According to a new study released by NerdWallet, credit card debt in the United States continues to increase. As of 2017, household credit card debt reached a balance of $15,654. Let’s compare the amount of money spent on credit card debt to a mortgage. Last year, Americans owed $8.74 trillion on their mortgages while owing $905 billion towards credit card debt. The amount of credit card is significant for many reasons.
Excessive credit card debt can be a barrier from entering the housing market. Let’s learn more.
One of the key metrics that the mortgage industry uses in assessing the potential borrower’s application is the debt-to-income ratio or DTI. It is determined by adding up all monthly debt payments and then dividing by the gross monthly income. For instance, let’s assume that a hypothetical borrower has the following monthly debt while earning $2,500 per month:
Credit Card $500/month
Student Loans $300/month
Short-Term Loan $100/month
Auto Loan $350/month
This means that this borrower’s DTI is 50% (500 + 300 + 100 + 350 divided by 2500). That is a high amount of debt compared to the earning potential of the applicant. Remember, debt-to-income ratio does not factor other essential living costs, such as food, insurance, clothes, transportation, and more.
Analysis has shown that borrowers with a higher debt-to-income ratio are more likely to struggle with repayment. The higher the DTI, the more difficult for a loan applicant to access credit. Often, this means a higher interest rate, as well.
The rise of credit card debt is a complex scenario. Annual median household incomes have increased by +20% over the past decade, which is great. This substantial increase in household incomes have outpaced the cost of living. Unfortunately, the cost of living is a blended average, which means when disaggregated by different types of costs, it can tell a different story.
For instance, medical expenses have increased by +35%. Food costs have increased +22%. And there are more. These are the types of expenses that often end up on a credit card. These costs have increased dramatically over the last ten years. More and more Americans are using credit to cover those rising costs, which accounts for the increase in credit card balances for the average household.
High-interest debt can be defined in two different ways. First, if you have an interest rate that is above average for that particular financial product, it could be considered high-interest. More often though, high-interest debt refers to a type of debt incurred via specific sources, such as credit cards, short-term loans, instant loans, and more. Companies offset their risk for such easily accessible credit with interest rates that are comparably high to other forms of lending.
High-interest debt, once accrued, is often challenging to pay off. This is because the interest repayment is so high. Much of the monthly payment is used to pay interest fees rather than the principal. If the principal remains untouched, then it’s a cycle of never-ending interest payments. Therefore, most financial planners recommend paying off high-interest debt first.
Pacific Union Financial
Pacific Union Financial, LLC is a full-service mortgage lender providing originations and loan servicing across the United States. A privately held direct lender with Fannie Mae, Freddie Mac, and Ginnie Mae approval, we originate loans through our Retail, Wholesale, and Correspondent channels. Let us know how we can help you expand your business.