Low-interest rates are normally a good thing for consumers. When borrowing costs are low, it puts more money back into people's pockets. People generally have higher disposable income, allowing them to make larger purchases and buy things they normally otherwise wouldn't like a new car or furniture. Even taking a nice vacation becomes much more affordable. And if their credit ratings are good enough, they're usually willing to take on the added risk of adding more debt to their list of liabilities.

While low rates are often a blessing to most individuals, there may be a pitfall. More debt can add to a person's burden—if things don't go well, a consumer won't be able to pay back their liabilities. This includes loans, car leases, mortgages, and credit card debt—one of the most common types of debt that consumers hold. But what does the environment look like right now for Americans and the credit card debt they hold? Keep reading to find out.

Key Takeaways

  • Credit card debt is generally an unsecured, revolving form of credit that cardholders can draw on regularly as long as they make payments.
  • Household credit card debt continues to drop as of the second quarter of 2020.
  • Delinquencies for credit card accounts dropped during the same period.

Credit Card Debt: The Basics

Credit card debt is generally an unsecured form of debt that the vast majority of consumers hold. It involves qualifying and applying for a revolving credit line through a lender, usually a bank or other financial institution. Lenders grant a card with a specific credit limit based on a consumer's credit rating, credit history, financial situation, as well as their relationship with the customer. Balances and payment history are reported regularly to the main three reporting agencies.

Customers can choose to pay their balances off in full every month. For those who don't, they must carry the unpaid balance month-to-month. This means they pay interest on the outstanding amount they owe. The rate charged by the lender is referred to as the annual percentage rate (APR), which is based on their credit history. And because they have a revolving limit, cardholders are able to reuse their credit after making payments to their cards.

You can save a lot of money by paying your credit card balances in full every month. If you don't, you'll pay more because interest is added to any outstanding balance you carry each month.

Snapshot of American Credit Card Debt

The Federal Reserve Bank of New York issues regular reports on the status of household debt across the United States. These reports are generated every quarter and are based on data collected from Equifax, which is one of the three major credit reporting agencies in the country. This data is drawn from a random national sampling taken from Equifax.

The report released in August 2020 showed that household debt dropped by $34 billion in the second quarter of 2020. This amounted to a total of $14.27 trillion in total household debt including mortgages, home equity lines of credit (HELOCs), auto loans, and credit cards.

Credit card debt dropped sharply from the first quarter by $76 billion to $820 billion. This was the steepest recorded drop in this type of debt since the time this data was first collected. Credit card debt also dropped on a year-to-year basis by $51 billion as of the second quarter of 2020. The number of new cards issued to consumers also dropped during the period. Credit limits for credit cards fell by $53 billion—the first drop since the fourth quarter of 2012. The report also highlighted a drop in delinquency rates during the second quarter of 2020 from the first—5.05% compared to 5.31%.

The changes in American credit card debt—from balances to new issuances and delinquencies—are largely due to the global COVID-19 pandemic. People curbed spending during the quarter because of lockdowns, business shutdowns, and social distancing guidelines. One of the main factors that contributed to the drop in late payments and delinquencies was the Coronavirus Aid, Relief, and Economic Security Act (CARES). It provided a series of initiatives to help consumers and businesses including loans and grants for small businesses, an expansion of unemployment benefits for those who were furloughed from their jobs. Many lenders also allowed payment deferrals on certain credit products.

What Does Falling Credit Card Debt Mean?

These findings were mirrored by TransUnion, another one of the major three credit reporting agencies. The report, published in July 2020, also indicated that the financial hardships consumers face are dropping, with credit card balances showing a decline in July for the fourth consecutive month. But even though borrowers aren't feeling the pinch, the performance of the personal credit market was still strong. This means delinquencies are and remain low.

But all of this may just be temporary. In fact, the agency expects to see delinquencies rise because of other economic factors. In addition, the stimulus packages and government intervention that is helping consumers and businesses may only be a short-term fix.

Credit card balances may also become a problem the next time a recession hits or if interest rates climb faster than household income rises. Consumers who normally pay their balances in full may start making smaller payments. Households that normally make minimum payments or slightly more than that may stop paying altogether, leading to a rise in delinquency rates. Seriously delinquent balances matter because lenders may never collect a penny on them. Then, as lenders lose money, consumers experience lower credit limits and tighter standards to get a credit card. If you were using credit during the Great Recession, you know all too well how this process works.

Other Household Debt

But what about other types of debt? As mentioned above, the total amount of household debt dropped during the quarter. As of June 30, 2020:

  • HELOC balances dropped $11 billion to $380 billion
  • Automobile debt declined by $3 billion to $1.34 trillion from the first quarter of the year 
  • Auto loans and leases continued to see more issuances during the quarter, to the tune of $136 billion in new contracts

Mortgage debt—the largest type of consumer household debt—did see an increase, though. According to the report, consumer files showed a total of $9.78 trillion in mortgage loans, an increase of $63 billion from Q1-2020.  New mortgages issued during the quarter amounted to $846 billion. This volume is the largest the market has seen since the boom in refinancing that took place in 2013.

Student loans also rose in the second quarter of the year to $1.54 trillion. This represents an increase of $2 billion from the previous quarter. Delinquencies in this category dropped from Q1 from 8.87% to 6.48%. This is, again, largely due to the stimulus efforts of the federal and state governments during the global COVID-19 pandemic.

The Bottom Line

Although a low-interest rate environment may entice consumers to take out more debt, many consumers are actually restraining their spending habits. Credit card balances and delinquencies are dropping, thanks to government aid and the pandemic that's sweeping the world. But since stimulus and the virus may be short-term, things could shift very quickly—something for which consumers need to brace themselves.