If you’re like most American families struggling to make it through this recession, you’ve seen your savings (if you had any) dwindle and your net worth shrink. At the same time, your debt level, as compared to your shrinking income, is growing.
It’s no surprise that so many are having a hard time, with near record unemployment and loss of income and net worth, all at a time when most Americans had run up historical levels of debt and historically low savings rates.
According to U.S. News and World Report, the average savings rate from the end of WWII to 1985 was between 6 – 10% of after tax income. From 1985 to 2005, that rate had shrunk to 0. One of the silver linings to the recession is that the average savings rate is climbing again, and is now around 4%.
Meanwhile, the debt level of the average American household had climbed steadily from a level of 55% in 1960 to a whopping 130% by 2008. Blame low down payment mortgages and increasingly easy credit for that ballooning, but since the credit crunch of ’08 that figure is only down to 125% of after tax income.
Think about that for a second. 125%. That means the average American family still owes 25% more than they earn in yearly income.
In the lending business, this amount of debt compared to income is know as a person’s debt to income ratio and it’s a big factor in determining who gets loans and for how much.
Another related ratio is the wealth to income ratio. This is the average household net worth to disposable income and it stands at 487% today. It may seem big, but the average since 1993 is 550%. This is due mostly to the losses in the stock market and housing prices.
This is not good news for the individuals out there, but it’s also not good for the economy as a whole. Remember the economy is made up of you and me and is based on you and me consuming goods and services. Economists fear that the majority of Americans are very likely to take what little disposable income is left to them and pay down debts.
While this is a smart thing to do on an individual level, it can be negative if too many people do this all at once. In fact, some economists speculate that it could lessen the GDP by 0.75% or more per year. This of course, would mean high unemployment and lack of job opportunity would last longer than if people were out spending this money.
Still, there are other views that have Americans getting back to the average wealth to income ratio without resorting to prolonged thrift. Remember that net worth is the difference between debt and asset value. So, if more Americans invest and buy appreciating assets, then the average net worth would grow and restore the collective wealth to income ratio to the average.
Still yet another scenario has inflation rising to levels not seen in a generation or more. This of course would put upward pressure on incomes, and help reduce the debt load by bringing the debt to income ratio back down, as incomes became larger relative to the debt.
My gut feeling is that reality rarely follows theory, and that we’re in for a little bit of everything – higher inflation, higher savings rates and some appreciation in asset value all resulting in a slow economy. Regardless of the outcome, it looks like we’re in for a long, slow recovery to “normal”.
I am starting to think all loans are complete rubbish, but we all need credit cards and i am struggling to find a credit card that has low rates that stay low for the life of the card, most offer low rates for 3 months and then they low out to 20+ percent