Charting the Future of Consumer Credit Risk

Rising consumer debt and delinquency rates are worrying. Financial stress among consumers could dampen future spending and economic growth, possibly leading to a recession. Ascending credit losses, moreover, may hurt bank profitability as net interest income drops with declining interest rates.

Cristian deRitis

A closer look beyond the headlines reveals that credit issues are concentrated in specific consumer groups, rather than posing a widespread economic risk. Let’s now explore the current state of consumer credit to identify troubled areas and potential opportunities in 2025.

The Big Picture

Outstanding balances on consumer debt rose to $16.7 trillion in September, according to the consumer credit bureau Equifax. This reflects a 1.5% increase from last year, lower than the average growth rate of 3.9% over the past three years. The growth in outstanding balances has slowed across loan types over the past year (except for home equity lines) and has decreased year-over-year for consumer finance, retail cards and student loans.

Sources: Equifax, BEA, Moody's Analytics

Though balances are up $3 trillion — or nearly 23% — from the end of 2019, most of this increase is attributable to mortgages and home equity lines of credit. Outside of real estate-backed loans, consumer debt rose from $3.8 trillion to $4.1 trillion, an increase of 9.5%. For context, aggregate personal income grew by 34% to $25 trillion over this period, pushing the household debt-to-income ratio to 67%, down from 73% in 2019 and 103% in 2009.

A more critical metric for assessing debt sustainability than the absolute level of debt or even the debt-to-income ratio is the debt service ratio, which is the percentage of disposable (after-tax) income households must allocate each month to meet their debt obligations. The data are encouraging here, with the ratio falling from 11.7% in the fourth quarter of 2019 to 11.5% in the second quarter of 2024.

Sources: Federal Reserve, Equifax, Moody's Analytics

Despite debt growth outpacing incomes during this time, most households lowered their monthly debt obligations by refinancing their mortgages at ultra-low interest rates. Given that nearly 85% of all outstanding debt obligations are locked into fixed-rate loans, households have, by and large, been insulated from interest rate hikes in recent years. With the Federal Reserve expected to cut short-term rates by one or two percentage points over the next couple of years, consumer balance sheets are expected to improve – especially for low-income households that may have a disproportionate share of their debt in variable rate credit cards or short-term personal loans.

Dealing with Delinquencies

The delinquency rate for all consumer credit products rose by six basis points to a seasonally adjusted 2.11% in October, reaching its highest point since March 2020. Although the proportion of overdue payments is at its peak for this cycle, consumer credit performance remains robust compared to historical averages. Overall, the rising trend in the total U.S. dollar delinquency rate indicates a return to typical patterns rather than a cause for alarm.

Sources: Equifax, Moody's Analytics

While more lower-income American households are missing loan payments than in the immediate aftermath of the pandemic, U.S. households in the middle-to-upper end of income distribution generally remain in relatively stable financial condition.

Breaking out the data at a more granular level, such as product, geography or credit score band, reveals that the rising delinquency trends have been driven by pockets of loans – including those to borrowers with low credit scores or those originated during the pandemic, when government stimulus payments may have indirectly inflated consumer credit scores.

Mortgage delinquency rates remain near historic lows due to the combination of solid underwriting, fast house-price appreciation, and the fact that the average interest rate on outstanding residential mortgages is about 300 basis points lower than recent mortgage rates. However, should house-price appreciation or income growth stall, increasing home equity line-of-credit balances could lead to elevated delinquency risks. Origination vintage effects, moreover, need to be considered, as first mortgages originated in 2023 may not have the home equity buffer that earlier borrowers may have.

Trends in Auto Loans and Credit Cards

Auto loan performance is stabilizing, with delinquency rates steady since April – despite being at their highest point since 2010. Loan amounts multiplied from 2020 to 2022, driven by the rise in new and used-car prices stemming from supply-chain disruptions.

With automobile price growth slowing and even declining, financially distressed borrowers have fewer options to sell their cars and extinguish their loan obligations than they had previously. Combined with weaker underwriting because of pandemic-era credit score inflation, auto loan charge-off rates have risen to cyclical highs. Tighter lending standards for more recent originations, however, should bring down auto delinquency rates in coming quarters.

Credit card balances, meanwhile, recently hit a record high, exceeding $1 trillion. Although growth has slowed significantly due to declining originations, balances have been expanding at above-average rates, as consumers have relied on credit cards to maintain their spending levels in the face of declining real wages and rising prices.

The delinquency rate on bank cards, moreover, remains at a 13-year peak – but should gradually improve as inflation subsides, provided the labor market remains strong. Vintage effects should also improve performance, as delinquency rates for bankcard debt issued in 2023 are lower across credit score bands than for cards issued in 2022.

Consumer lending, meanwhile, has become more restrictive, because of economic uncertainty, declining interest income, and banks' selectivity with borrower approvals. Delinquency risk and charge-off rates, however, are expected to decrease in the upcoming quarters because of stricter lending standards.

Lastly, credit originations are declining, due to weak loan demand and consistently stringent lending standards. Analysis by credit score reveals that originations have decreased for individuals with scores ranging from 620 to 779. In contrast, those with scores below 620 and above 780 have increased their borrowing in the past two quarters. Mortgage-related debt has seen the most pronounced reduction in originations.

Outlook and Risks

The U.S. economy is progressing steadily but will likely slow down over the next few quarters. Moody’s Analytics predicts inflation-adjusted growth to average 2.1% in 2025, indicating balanced growth without causing high unemployment or increasing inflation. This period should also see easing inflation and labor market stabilization, allowing the Federal Reserve to reduce interest rates again.

Consumer credit markets are expected to slow down in tandem with the economy's pace over the next year, but will rebound once interest rates decrease sufficiently and inflation risks subside. Balance growth is anticipated to decline from its 2023 rate of 4.5% to approximately 1.9% in 2024, reaching 2.1% in 2025 before accelerating again.

Credit products most influenced by labor market changes, such as credit cards and consumer finance loans, will be key contributors to the decrease in balance growth. Concurrently, delinquency rates across all loan types will increase until 2025 but stabilize slightly above pre-pandemic levels, as the poorly performing origination vintages from 2022 and 2023 phase out.

The primary risk to this forecast is a potential misstep by the Federal Reserve. Fed officials have acknowledged that the balance between inflation and the labor market has been restored, and further declines in job market conditions are undesirable. Therefore, any delay in implementing additional rate cuts presents a risk, especially given the vital link between consumer credit delinquency and unemployment.

Cristian deRitis is Managing Director and Deputy Chief Economist at Moody's Analytics. As the head of econometric model research and development, he specializes in the analysis of current and future economic conditions, scenario design, consumer credit markets and housing. In addition to his published research, Cristian is a co-host on the popular Inside Economics Podcast. He can be reached at cristian.deritis@moodys.com.