What Is Consumer Debt?

Consumer debt consists of personal debts that are owed as a result of purchasing goods that are used for individual or household consumption. These stand in contrast to other debts that are used for investments in running a business or debt incurred through government operations. Some examples of consumer debt are: credit cards; student loans; auto loans; mortgages; and payday loans.

Key Takeaways

  • Consumer debt consists of those loans used for personal consumption as opposed to debts derived from businesses or government activities.
  • Consumer debt may be segmented into revolving debt, which is paid monthly and may have a variable rate; and non-revolving debt, paid as a fixed rate.
  • Consumer debt is considered by economists to be a suboptimal form of financing as it often comes with high interest rates that can be difficult to pay off by some segments of the population.
  • The consumer leverage ratio (CLR) is an economic indicator that tracks the aggregate level of consumer debt in a country.

Understanding Consumer Debt

Consumer loans can be borrowed from a bank, the federal government, and credit unions, and are broken down into two categories: revolving debt and non-revolving debt. Revolving debt is paid down on a monthly basis, such as credit cards, whereas non-revolving debt is a fixed-payment loan held for the entirety of the time that the item is in possession. Non-revolving credit usually includes auto loans and school loans.

Advantages and Disadvantages of Consumer Debt

Consumer debt is considered a financially suboptimal means of financing as the interest rates on doing so are extremely high, such as on credit cards, when compared to rates on mortgages. Furthermore, the items purchased typically do not provide a necessary utility and do not appreciate in value that would justify taking on that debt.

An opposite view on the negatives of consumer debt is that it results in increased consumer spending and production, growing the economy, and results in a smoothing of consumption. For example, people borrow at earlier stages in their lives for education and housing, and then pay down that debt later in life when they are earning higher incomes.

When the debt is used for education, it can be viewed as a means to an end. The education allows for better-paying jobs in the future, which creates an upward trajectory for both the individual and the economy.

Regardless of the pros and cons, consumer debt in the United States is on the rise due to the ease of obtaining financing matched with the high level of interest rates. As of June 2019, consumer debt was $4.1 trillion, with the breakdown being $3.03 trillion of non-revolving debt and $1.072 trillion of revolving debt. If not managed properly, consumer debt can be financially crushing and adversely impact an individual's credit score, hindering their ability to borrow in the future.


Prioritizing Debt

The Consumer Leverage Ratio

The consumer leverage ratio (CLR) measures the amount of debt that the average American consumer holds, compared with their disposable income. The formula is as follows:

Consumer leverage ratio
Consumer Leverage Ratio Formula. Investopedia

Total household debt is derived from the Federal Reserve’s report, while disposable personal income is reported by the U.S. Bureau of Economic Analysis. The CLR has been used as a litmus test for the health of the U.S. economy, along with other indicators, such as the stock market, inventory levels, and the unemployment rate.

On an individual level, the consumer leverage ratio is advised to be between 10% and 20% of an individual's take-home pay. Above 20% is an indicator of urgent debt problems.

Consumer Debt and Predatory Lending

Consumer debt is often associated with predatory lending, broadly defined by the FDIC as “imposing unfair and abusive loan terms on borrowers." Predatory lending often targets groups with less access to and understanding of more traditional forms of financing. Predatory lenders can charge unreasonably high interest rates and require significant collateral in the likely event a borrower defaults.