American households added 2% on average to their debt burden in the second quarter of 2022. Now, the collective debt burden of all Americans is worth a staggering $16.15 trillion, according to figures from the Federal Reserve.
To put that into context: Americans have nearly as much debt as China’s entire gross domestic product (GDP). It’s six-and-a-half times greater than Apple’s market value. Put simply, it’s a gigantic pile of IOUs.
This burden is likely to become heavier and larger in the months ahead. Northwestern Mutual's 2022 Planning & Progress Study found that more than four in 10 (43%) of U.S. adults plan to add more debt in the months ahead to keep up with the rising cost of living.
Here’s how that impacts the economy and what you can do to avoid this debt trap.
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Economic impact
The economic impact of debt is determined by two factors: the cost of debt and its use.
If consumers have borrowed money at low interest rates to buy appreciating assets, that is generally considered “good debt.” Unfortunately, American debt is looking increasingly “bad” this year.
The vast majority of U.S. household debt is housing related. Housing debt accounts for 72% of the total debt balance as of the first half of 2022.
And mortgage rates have climbed significantly in recent months, which means this form of debt is even more expensive. Average 30-year mortgage rates have hit 5.5% — up from 3.22% at the start of the year. Meanwhile, some economists expect housing prices to slump in the years ahead.
Household debt is a leading indicator of recessions. And the fact that households may have to pay more for a depreciating asset is likely to be a drag on the economy.
Consumers must tackle this issue to protect themselves from an economic shock.
Tackle debt
There are two methods to mitigate debt. Borrowers can implement a long-term repayment plan that systematically reduces their debt burden over time. Or they may consolidate their debt to lower its cost and make it easier to manage.
For most borrowers, a combination of both these methods could be the best approach. Here’s a closer look at how these strategies work.
Debt repayment plan
A debt repayment plan could help consumers gradually reduce their debt burden. Borrowers either pay their largest balance (the snowball method) or highest interest rate (avalanche method) loans first while making just minimum payments on all other loans.