As policy makers and researchers continue to express concern over the rising percentage of older Americans carrying debt, it is important to understand that not all types of debt are necessarily detrimental. For instance, taking out a low-interest mortgage to purchase a home, which typically appreciates in value, can be considered a wise financial decision. On the other hand, individuals who accumulate unpaid credit card balances may find their debt spiraling out of control, leading to financial distress.
In order to gain a better understanding of the percentage of households at “high risk” and “low risk” of financial hardship, as well as whether these high-risk households can be grouped into distinct categories, a recent study was conducted by a team of researchers.
Identifying High-Risk Households
To begin, the study aimed to determine the number of households at high risk. Various factors, such as secured versus unsecured debt, debt payment-to-income ratio, and debt-to-assets ratio, which are commonly used by lenders and researchers, were taken into consideration (see Table 1). The classification identified any households with revolving credit card debt as “high risk,” as these borrowers are more likely to face unfavorable outcomes compared to those without revolving credit card debt.
The results of the classification exercise clearly demonstrate that overall growth is primarily driven by high-risk households (see Figure 1).
Understanding the High-Risk Subgroups
In order to develop effective policy solutions, it is crucial to comprehend the reasons behind the financial troubles faced by high-risk households. To address this, the researchers utilized a technique that revealed four distinct subgroups within the high-risk borrowers category.
- The largest subgroup (33%) consists of financially constrained households that have low levels of wealth, often carry excessive debt burdens, and struggle to meet essential needs. For these individuals, borrowing becomes a means of simply getting by.
By delving deeper into the characteristics and circumstances of these distinct high-risk subgroups, policymakers can develop targeted strategies to alleviate their financial burdens and improve their overall well-being.
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Understanding Different Subgroups of Borrowers
In a recent study, different subgroups of borrowers were identified based on their financial characteristics. The findings shed light on the diverse nature of high-risk borrowers and emphasize the need for tailored solutions to address their financial vulnerability.
Subgroup 1: Credit-Card Borrowers
Approximately 26% of borrowers fall into this subgroup, which consists of middle-wealth households that seemingly have no urgent need to borrow. Despite their financial stability, a significant portion of their income is dedicated to debt payments. Furthermore, around 80% of them carry credit-card debt, and over a third of them possess second homes.
Subgroup 2: Low/Middle-Wealth Households with High Housing Debt
About 19% of borrowers belong to this subgroup, primarily comprising low/middle-wealth households. Their housing debt payments consume more than 40% of their income. This group also exhibits a disproportionate representation of nonwhite individuals.
Subgroup 3: Wealthy Spenders
The last subgroup, comprising 23% of borrowers, consists of seemingly affluent individuals who fall within the top third of the wealth distribution. Surprisingly, approximately a quarter of their income is allocated towards debt payments. Additionally, the majority of them carry credit-card debt, and a significant portion has second homes.
Tailored Solutions for High-Risk Borrowers
Addressing the financial vulnerability of high-risk borrowers requires an understanding of their diverse characteristics. A one-size-fits-all solution does not exist, but various strategies can help mitigate their financial risks.
Financially Constrained Households
For households constrained by financial resources, debt counseling and consolidation may provide some relief. However, additional support is necessary as many struggle to meet their basic needs.
Credit-Card Borrowers
Financial counseling and legislation mandating credit-card issuers to offer improved consumer information can assist credit-card borrowers in making more informed financial decisions.
Households with High Housing Debt
Efforts to reduce housing burdens, such as refinancing or downsizing, are most suitable for households overwhelmed by excessive housing debt.
Wealthy Spenders
Considering that many wealthy spenders own second homes, selling these properties can serve as a viable strategy to manage their debt effectively.
Key Takeaways
This study emphasizes two significant findings. Firstly, the escalating debt levels among older households should not be disregarded as a benign phenomenon. Secondly, the diverse characteristics of high-risk borrowers necessitate an array of policy responses to address their financial vulnerability.
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