DEFINITION of 'Peak Debt'

Peak Debt is the point at which a household or economy's interest payments become so high compared with income that a halt in spending must occur. This is typically followed by a period of debt reduction.

BREAKING DOWN 'Peak Debt'

The term "peak debt" is said to have been coined by Jaswant Jain, Ph.D., in 2006. Jain concluded that the debt taken on by an economy such as the U.S. economy is important to increase consumption. Debt will eventually rise to a certain exhaustion point. At this point consumption must be cut to pay the interest and debt services.

This action requires a reduction in future spending as well, which has a depressionary effect and leads to a reduction in borrowing.

All That Debt

Peak debt as it applies to economies is debatable. According to the International Monetary Fund (IMF) in 2018, the world's economies were 12% of GDP deeper in debt than at the peak debt cycle during the financial crisis in 2009, or some $164 trillion. That's a high equal to 225% of GDP, the IMF said. China was singled out as a major factor behind rising debt levels, but Japan and the United States account for half of that debt.

Still, most households in the U.S. are doing fine. Household debt, after peaking in 2010 at 13% of disposable income has steadily declined to around 10% in 2018. 

The consumer leverage ratio (CLR) measures the amount of debt the average American consumer holds, compared with his or her disposable income.

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

On an individual level, the consumer leverage ratio is advised to be no more than 20 percent of an one's take-home pay. Long-term consumer debt is usually considered fiscally suboptimal, particularly as most consumer goods (e.g. a new flat screen television) do not have high levels of utility that justify incurring short-term debt.

If your household has reached peak debt, it's time to consider debt counseling and or personal bankruptcy. These are had steps to take but once your fixed payments outstrip you income, you'll either have to keep borrowing to stay afloat or cut your expenses drastically. Even then, without a turnaround plan, retiring that debt will seem insurmountable.

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