FRBSF Economic Letter
2006-18; July 28, 2006
Property Debt Burdens
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With households' property debt surging, the use of adjustable-rate
mortgages increasing, and interest rates rising, some observers
have raised concerns about households' ability to service that
debt. To gain a better idea of the distribution of property debt
burdens and how it has changed over time, this Economic Letter
presents data from the Survey of Consumer Finances (SCF), which
contains information on different types of property debt, debt
service, and income. The SCF data show that property debt burdens
in 2004 were only slightly higher than they were in the mid-1990s.
Also, although the use of adjustable-rate mortgages has increased,
many households that have some of their property debt in these
instruments have fairly low debt burdens, suggesting that they
could successfully adapt if their mortgage payments were to increase.
Defining property debt, debt service, and debt burden
We begin with some definitions. "Property debt" is
any debt backed by any of the household's residential real
estate (mortgages, home equity loans, and land contracts). According
to the Flow of Funds data from the Federal Reserve, mortgages
alone make up nearly 90% of the total debt held by U.S. households.
Although studying the level of debt is important, we are
more interested in the amount a household's creditors expect
each
year in repayment (for instance, the "minimum payment" on
a bill), a concept known as "debt service." The
amount of debt service per year depends on a number of
factors, including
the interest rates charged on the loans (higher interest
rates lead to higher required payments).
Finally, the impact of the debt depends on a household's
income; all else equal, the higher its income, the easier
it is to
pay a given level of debt service. To facilitate comparisons
among
households, we compute a measure called "debt burden," which
is the household's annual debt service divided by annual pre-tax
income. For example, a household with a debt burden over 0.5
has to spend more than half its income servicing debts and might
be described as heavily "stressed" or "leveraged," while
one with a debt burden of 0.01 spends only 1% of its
income on debts and should have less difficulty in making
debt service
payments.
Unfortunately, obtaining reliable data on debt burdens
(that is, data that contain information on a household's
income
and on a thorough portrayal of debt and debt service)
is difficult.
One of the few consistent data sources over time has
been a survey conducted by the Federal Reserve Board
called
the Survey
of Consumer
Finances (SCF), which is conducted every three years.
The most recent SCF data, for 2004, were released earlier
this
year
and are summarized in Bucks, Kennickell, and Moore
(2006).
Basic facts for households with some property debt
In recent years, the percent of households with some
property debt has increased, in part reflecting
an increase in the
share of households that are homeowners. Based
on the SCF, the share
of households with property debt was 49% in 2004,
compared to 41% in 1989 (these numbers are lower than the
homeownership
rate
because some homeowners have no property debt).
 To provide some sense of how debt burdens have
varied over time for households with at least
some property
debt, Figure
1 shows
the median property debt burden from 1989 to
2004. This measure, also called the 50th percentile,
tells us the
debt burden
for the household in the middle of the distribution;
half the households
have higher debt burdens than this, and half
have lower debt burdens. We use it here in preference
to the mean,
or average,
because it is less sensitive to the extremes
and therefore provides a better picture of the typical
household's
property debt burden.
Debt burdens have increased modestly, on net,
from 1989 through 2004. The median property
debt burden
was 0.14
in 1989, and
rose to 0.16 in 1992; it then increased slowly
over the next decade
(aside from a blip in 2001), moving up to 0.17
in 2004. While this is the highest level shown
in Figure
1,
it is less than
a percentage point higher than the level reached
in 1995.
 To provide more insight into debt burdens than
we can get from examining the median, Figure
2 shows
the distribution
of property
debt burdens for two years, 1995 and 2004.
Notably, the distribution has shifted slightly
towards
higher debt
burdens
over this
period. However, this shift is small enough
that the 1995 and 2004 distributions
remain similar. As in every year since 1989
a majority of households that had property
debt
in 2004 devoted
less than
20% of their
incomes to servicing that debt.
Ideally, one would like to be able to focus
on those households most at risk of default.
However,
the
SCF data do not allow
us to track the same households over time
to examine how transitory or permanent
their debt
burdens
are. What we
do know from the
data is that the share of households with
high debt burdens is
similar now to what it has been in past
years. In 2004 about 5.5% of households with property
debt
had debt
burdens over
0.50, roughly similar to the fraction in
earlier survey years.
Adjustable-rate mortgages
A key area of household property debt that
has raised concern is the use of adjustable-rate
mortgages. With an adjustable-rate
mortgage, a household may have a modest
debt burden today that becomes quite
onerous as
the
interest
rate on the
mortgage moves up. According to the
2004 SCF, 33% of households that
have property
debt have at least a portion in an
adjustable-rate loan (we assume home equity loans have
adjustable interest rates, while
land
contracts do not). This is an increase
from 23% in
2001
and
25% in 1998. Although some households
hold a small fraction of their
total property debt in adjustable-rate
instruments, more than one-half of
households with adjustable-rate
property
loans
in 2004 had all of their property debt
in these instruments.
 Figure 3 shows the 2004 distribution
of households' home debt burdens
by whether or not they
have an adjustable-rate property
loan. It seems that holders of adjustable-rate
loans fit almost exactly the same
pattern as other households.
They
are more
likely to have debt burdens in the
range of 0.2 to 0.4,
but all the
differences are small. These statistics
suggest that most households that
use adjustable-rate
loans are
not using
the lower interest
rates to fund insupportably large
debts.
Although the distribution of debt
burdens in 2004 appears roughly
similar to
what it was
a decade
ago, there
is great uncertainty
over how the future distribution
of debt burdens will look. As adjustable-rate
mortgage payments
increase, some households
may
have difficulty servicing the higher
debt. At the same
time, many may be able to respond
to
these higher debt burdens
in a number of ways, including
refinancing and reducing the level
of property debt.
It is difficult to say much about
households' ability to manage
growing debt burdens
from adjustable-rate mortgages
in the future relying mainly
on the
data from
the SCF. The SCF does not contain
information after 2004, so we
lack data on how things stand
under current interest rates.
Other data sources tell us that in 2005
the use of adjustable-rate mortgages
increased and, according to the
Flow of Funds data,
households increased
their
mortgage debt by another 14.1%
in 2005. We do not
yet know how these
changes have affected the distribution
of debt burdens.
Conclusion
The SCF data show that property debt burdens in 2004 were only
slightly higher than they were in the mid-1990s. Also, although
the use of adjustable-rate mortgages has increased, many
households that have some of their property debt in adjustable-rate
mortgages
have fairly low debt burdens, and may be able to adapt successfully
to higher interest rates. However, there may still be some
households that face financial distress as their mortgage
payments increase.
Mark Doms
Senior Economist Meryl Motika
Research Associate
References
[URLs accessed July 2006.]
Board of Governors of the Federal Reserve System. 2006. "Flow
of Funds Accounts of the United States: Flows and Outstandings,
Fourth Quarter 2005."
Bucks, B., A. Kennickell, and K. Moore. 2006. "Recent
Changes in U.S. Family Finances: Evidence from the 2001 and 2004
Survey
of Consumer Finances." Federal Reserve Bulletin 92,
pp. A1-A38.
Opinions expressed in this newsletter
do not necessarily reflect the views of the management
of the Federal Reserve Bank of San Francisco or of the
Board of Governors of the Federal Reserve System. Comments?
Questions? Contact
us via e-mail or write us at:
Research Department
Federal Reserve Bank of San Francisco
P.O. Box 7702
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