Are Higher Rates a Liability for Households?

Despite low rates, households have not ramped up demand for credit to meet prerecession levels. A future hike in the fed funds rate could limit credit growth further.

More Wealth Not Spurring Borrowing

Easier monetary policy and historically low interest rates have led to large gains in households’ financial assets over the past several years. This in turn has caused households’ net worth to strengthen—growing 6-plus percent year-over-year in each of the past 9 quarters. Households have more wealth at their disposal given the 10 percent-plus annual gains seen in the S&P 500 index in each of the past three years and the reduced interest rate burden on prior debts. Historically this increase in wealth as a percent of disposable income has moved closely with higher spending and borrowing in the past (top chart).

However, despite an increase in household net worth, consumers have been slow to spend and to take on additional liabilities since the past recession (middle chart). Slow borrowing growth has been seen across all loan types, but the demand for mortgages in particular has been slow to take off. In fact, the mortgage debt service ratio rose to 7 percent prior to the past recession, but has since followed a downward trend and remains at just 4.7 percent. Other loan types have seen a stronger recovery, including various forms of consumer credit, like student and auto loans.

Credit Growth Limited by ZIRP

In the past, monetary policymakers were able to boost household borrowing and spending by decreasing interest rates. The current near-zero interest rate policy from the Federal Reserve Board has reduced the ability of policymakers to spur lending further. Across loan categories, interest rates remain historically low. The conventional 30-year mortgage rate, which peaked in 2007 at 7.2 percent, has since fallen more than 3 percentage points to 3.9 percent. Auto loan rates have fared the same, falling from a peak of almost 18 percent for a 48-month new car loan to just above 4 percent at present. Yet, despite low rates and the increasingly accommodative lending environment, consumers have not returned to the borrowing market in a meaningful way, in part due to tighter credit conditions and reduced credit quality. This absence of demand raises questions for the consumer lending market as the Federal Reserve begins to raise rates later this year. We suspect that a hike in the fed funds rate, which would result in higher borrowing costs for consumers, might restrain credit demand even further, despite stronger income growth. In addition, a stronger rate environment could also incentivize saving.

Increasing household net worth and stronger balance sheets should result in more credit-worthy borrowers. Lower charge-off rates at commercial banks indicates that the credit market continues to improve, yet the lessons of the past recession and the after-effects of large values of credit defaults may weigh on credit expansion for some time (bottom chart).