Household debt service drops to a record low

Data from the Federal Reserve show the household financial obligations ratio, minimum debt service payments plus other financial obligation payments as a share of disposable income, plunged to an all-time low of 13.64% in the second quarter. Within that measure, the total debt service ratio, minimum debt services payments as a share of disposable income, dropped to 8.69% with mortgage debt service coming in at 3.72% and other consumer debt service requiring 4.97%.

However, disposable personal income for the second quarter was significantly distorted by the massive government transfer payments distributed to offset some of the carnage due to government lockdown policies. Government transfers more than doubled from $3.2 trillion at a seasonally-adjusted annual rate in February to $6.6 trillion in April.

Those transfers pushed disposable personal income to $19.0 trillion in April from $16.8 trillion in February. If those transfer payments are excluded, disposable personal income would plunge to $12.4 trillion in April from $13.6 trillion in February.

If the financial obligations ratio were recalculated using the disposable income excluding transfers data, the ratio would jump to 19.8% in the second quarter from 18.6% in the first quarter. While that is about midway in the roughly 18% to 22% range since 1980, it tells a very different story than the financial obligations ratio based on total disposable personal income.

Debt service may become a bigger issue as transfer payments dwindle. Elevated levels of unemployment and ongoing restrictions may lead to worsening financial health including rising bankruptcies for households and businesses. Overall, risks to the economy remain significant.

Robert Hughes joined American Institute for Economic Research in 2013 following more than 25 years in economic and financial markets research on Wall Street. He was formerly the head of Global Equity Strategy for Brown Brothers Harriman, where he developed equity investment strategy combining top-down macro analysis with bottom-up fundamentals. He served as senior equity strategist for State Street Global Markets, senior economic strategist with Prudential Equity Group and senior economist and financial markets analyst for Citicorp Investment Services. Bob has a master’s degree in economics from Fordham University and a bachelor’s degree in business from Lehigh University.