With inflation continuing to rankle consumers across the US, the Federal Reserve has already taken steps to reduce rising costs. Chief among these steps is an increase to interest rates.
Unfortunately, many Americans turn to credit card borrowing during times of an economic squeeze. This practice may lead to even greater trouble given credit card interest rates are rising in step with the Federal rate increase. With consumer debt on the rise and potential further interest rate hikes in the months to come, debt consolidation loans may play an important part in offering some consumers financial stability.
Credit Card Spending Rebounds
During 2020 and 2021 – arguably the two years of the pandemic with the most outsized impact on consumers – consumer credit card debt dropped dramatically from the years prior. We can chalk this debt reduction up to a consumer base choosing to spend far more carefully with their credit cards, as well as the financial assistance and allowances offered by card issuers.
Now the pendulum is mid-swing in the other direction: consumer credit card balances have reached an astounding $887 billion as of July. We can lay this figure at the feet of inflation as more consumers turn back to their credit cards to help cover costs.
Ideally, consumers shouldn’t use their credit card on any purchase they don’t plan on paying off that same month. But with essentials like food and gas up in price by as much as 13.1% and 44% from last year respectively, many US consumers have no other choice but to carry a balance.
Rising Debt, Rising Costs
Credit card debt isn’t the only type of debt on the rise. Total household debt overall also increased over last year by 1.7%, sitting at $15.84 trillion in total. There are a few notable causes of this increase, including mortgages, student loan debt and auto loans.
Mortgage debt makes up a significant percentage of the average household’s debt. While this has always been the case, the booming housing market has pushed that percentage even higher to 71%. And US consumers took out roughly $177 billion in auto loans during the first quarter of 2022, a significant number in part thanks to rising auto prices.
Thankfully, the Federal Reserve Bank of New York notes that the amount of debt transitioning into delinquency remains historically low, though nearly all types of debt did see a modest increase in delinquency from 2021.
Balance Transfers May Not Cut It
Considering the average family is now spending $5,000 at the gas pump compared to $2,800 from just a year ago, it’s not unreasonable for families to turn to credit cards to stretch their finances. But with the average family’s debt sitting at around $145,000, effectively managing to pay off this debt as soon as possible while minimizing interest is a little trickier than usual in today’s economy.
Under typical circumstances, balance transfer credit cards are an excellent opportunity to consolidate debts at a lower interest rate – usually an intro rate of 0% for 12 months or more. But after that intro period, balance transfer credit cards are subject to the rising federal interest rates we’ve seen and that may continue into late 2022. If a consumer can’t pay off their debt within the intro period, they could well end up with a rather high interest rate on their consolidated debt – and one that could rise further.
The other issue with balance transfer credit cards is consolidation limits. A balance transfer credit card can only transfer debt up to the limit of the credit card itself. While consumers might squeeze $10,000 onto a card if they have good credit, your average family will still have much more that can’t or won’t fit onto the card.
Debt Consolidation Loans May Offer Relief
Given US consumer debt levels and the limitations and interest rate changes of credit cards, debt consolidation loans may well receive a surge in late 2022 into 2023. Unlike a balance transfer credit card, a debt consolidation loan is meant to provide a longer-term debt relief solution for larger debt amounts than you could fit onto a credit card.
Debt consolidation generally allows loans between $2,000 and $50,000, or even as high as $100,000 depending on the lender and your finances. They come with an average APR of around 9%, though this can range, but crucially, these interest rates are often fixed. This is a major boon for families that need to relieve large amounts of debt over a long period of time as they’re shielded from factors like rising Federal interest rates.
The exact terms of a debt consolidation loan depend on a consumer’s creditworthiness, so not all consumers will get the longest terms of the lowest interest rates. But as we observed in 2020 and 2021, the average American’s credit score jumped several points on account of measured pandemic spending, leaving many more Americans in a position to take advantage of that score toward this sort of purpose. Of course, each consumer’s financial needs will vary.
Time will tell how long this inflation will last, but consumers will need to take steps to relieve their accrued debt and growing interest in the months and years to come.