U.S. households are reducing their debt -- that much we know. But at the same time, incomes have been slowly creeping up. If you put these two facts together, then you quickly arrive at an important conclusion: debt is becoming less of a burden for the average American household. In fact, in the second quarter, the U.S. economy hit a somewhat significant milestone for debt affordability.
Here's a chart showing the ratio of total household debt based on New York Federal Reserve data and annualized disposable personal income according to the Bureau of Economic Analysis. I chose to use disposable income, since that's after-tax earnings that can actually be used to make debt payments.
In the second quarter, the ratio was 98.7%. The quarter marked the first time that the total debt-to-disposable income ratio fell below 100% since 2004. The ratio peaked at 115.2% in the last quarter of 2007, as the recession began.
But as you can also see from this chart, the ratio has a long way to go if it's aiming for levels seen in the late 1990s. During the first half of 1999, the ratio was below 70%.
What this ratio doesn't show, however, is how affordable this debt actually is. You could learn that by the even more important ratio of payment-to-income. Without knowing the interest rates on household debt over the past decade, we can't be sure that the debt burden is more manageable now than it was in 2004. If the average interest rate on this debt is lower now, for example, then it is even more affordable at this time. This could be the case, considering that we've been in an ultra-low interest rate environment for a couple of years now.
But even by just considering debt-to-income, we can be pretty sure that the average household balance sheet looks a lot healthier now than it did over the past couple of years. Yet the question remains: how far will this ratio have to fall before Americans feel comfortable enough with their debt levels that they begin to borrow more aggressively?