Households Better Prepared for Rate Increases This Time

Earlier this week Freddie Mac asked if the housing market recovery could withstand a rate increase (the answer, with some qualification was yes).  Now the economists at Wells Fargo are asking the same about household balance sheets.

The banks Interest Rate Weekly concludes that should the Federal Reserve begin to increase rates as expected it will have a "muted" impact on households.  The balance sheets of households are critical to the economy as a whole given their importance to growth in consumer spending.

Households are less leveraged than they were in past tightening cycles and thus in a better position to withstand the higher rates. Financial obligations for debt, property taxes and lease payments currently stand at 15.3 percent of disposable income, a level consistent with the record lows of the early 1980s.  When the last previous tightening cycle began in 2004 the financial obligation ratio (FOR) was 16.7 which was 1.4 points higher than today.  Additionally a higher savings rate is providing households with an extra cushion against rising borrowing costs.

Part of the balance sheet dynamic is a national shift to fixed rate mortgages.  At the end of the last tightening cycle in 2006, 44 percent of mortgages carried adjustable rates.  As interest rates declined homeowners switched to fixed rates and adjustable rate mortgages (ARMS) dropped to only 2.5 percent of the outstanding mortgage debt at the height of the Great Recession.  That market share has since increased but today only 18 percent of the $8.2 trillion in mortgage debt is in ARMs.  This means that, as of the first quarter of 2015 only $1.5 trillion of that debt would be affected by increasing rates compared to about 30 percent or $2.5 trillion that was vulnerable in the mid-2000s tightening period. New borrowers, whether taking fixed or adjustable rate mortgages, will be affected by rate hikes but many fewer existing borrowers will be impacted.

Households are better prepared for a rising interest rate scenario in more general terms as well.  Delinquency rates, except for student loans, are better, or at least no worse, than in the past recession and more mortgages are being brought current than are falling behind.  Foreclosures and bankruptcies are declining.  Households, the banks says, are also savvier about their finances and Congress has made several changes to enforce greater transparency on the part of those issuing credit.