Consumer Debt: Understanding the Pros and Cons

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. Credit card debt, student loans, auto loans, mortgages, and payday loans are all examples of consumer debt. These stand in contrast to other debts that are used for investments in running a business or debt incurred through government operations.

Key Takeaways

  • Consumer debt consists of those loans used for personal consumption as opposed to debts incurred by businesses or through 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 become difficult to pay off.
  • 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 extended by 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 the loan of a lump sum upfront with fixed payments over a defined term. 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 because the interest rates charged on the debt, such as credit card balances, are extremely high when compared to mortgage interest rates. Furthermore, the items purchased typically do not provide a necessary utility and do not appreciate in value, which might justify taking on that debt.

An opposite view is that consumer debt results in increased consumer spending and production, thereby growing the economy and achieving 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. 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 May 2024, consumer debt was $5.02 trillion, with $3.72 trillion in non-revolving debt and $1.3 trillion in 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.

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:

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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 considered to be any lending that places unfair and abusive terms on the borrower.

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.

What Is Considered Consumer Debt?

Consumer debt is personal debt that has accumulated from the purchase of consumer goods for personal use. This includes student loans, auto loans, credit card debt, and mortgages.

What Is Good Consumer Debt?

Debt can be good if it is managed properly because it allows you to build up a credit history, which makes it easy to borrow money for future purchases if need be. Mortgages are considered good consumer debt because you are spending money to build up your wealth. Additionally, having such debt will improve your credit profile if you are making payments on time.

What Are the Effects of High Levels of Consumer Debt?

High levels of consumer debt can have wide-reaching negative impacts. High levels of consumer debt put people in a precarious financial condition. This can lead to bankruptcies, foreclosures, defaults, and more if the economy worsens and people aren't able to make debt payments. Additionally, if people are spending more of their income on paying down debt, they are not spending it in the economy, which can adversely impact GDP and other economic metrics.

The Bottom Line

High levels of debt in the United States are an issue. If not managed correctly, debt can make it difficult to build wealth, save for retirement, pay for a kid's college, create an emergency fund, and not to mention the emotional toll of increased stress and depression.

It's best to put in a plan to manage debt and reduce it as fast as you can. If you need help, there are services available to help you manage your debt.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Board of Governors of the Federal Reserve System. "Consumer Credit - G.19."

  2. U.S. Bureau of Economic Analysis. "Disposable Personal Income."

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