U.S. household balance sheets strong, but high rates could add strain

U.S. consumers are on more solid footing thanks to lower interest rates and loan forbearance programs during the pandemic that allowed them to pay down debt and build up cash, according to new research from the Federal Reserve Bank of New York.

Still, it’s hard to determine how much households have left in excess savings, and some could face more strain over time now that student loan payments are returning and interest rates have risen, the researchers said in a series of blog posts published on Wednesday.

“Overall, households report solid and stable expectations for spending growth, consistent with our evidence on the strength and liquidity of household balance sheets, including relatively low delinquencies,” the researchers wrote.

“Of course, the period of very low interest rates that supported many of these developments is decidedly over, at least for now, suggesting that household finances will likely tighten further in the coming months.”

Homeowners who refinanced loans to lower rates during the pandemic benefited from smaller mortgage payments, freeing up cash that could be used to pay down debt, build savings or support spending, research showed.

Many homeowners withdrew home equity from their properties, providing them with about $280 billion extra as of the second quarter this year.

The Fed has raised interest rates aggressively since March 2022 to combat high inflation, bringing its benchmark rate from near zero to above 5%, the highest level in 22 years.

U.S. consumers have so far remained resilient, with retail sales exceeding all forecasts and employment surging unexpectedly last month.

But some households could begin to feel the squeeze from interest rates that are expected to remain high next year.

As more people buy homes and cars at higher rates, more consumers will face larger payments that could leave them with less spending cash, the researchers said.

Debt burden

The resumption of federal student-loan payments, which are restarting this month after being halted in early 2020, are not expected to have a substantial effect on consumer spending or the economy, the researchers said.

Some borrowers paid off some or all of their loans before this month to avoid interest charges.

Many households will also face smaller monthly payments than they did before the pandemic thanks to changes rolled out by the Biden administration to income-based repayment plans.

But some consumers, including women, low-income borrowers and those who took on student debt but did not complete their degrees, could struggle more to make payments.

“Some student-loan borrowers will surely struggle managing their debt obligations just as before the pandemic forbearance,” the researchers wrote.

“Nevertheless, we expect the potential spillover to the broader economy to be limited, and we will continue to monitor developments in the coming months.”