A Look at the Consumer Debt Situation

In this podcast, Motley Fool host Ricky Mulvey and analyst Bill Barker discuss:

• Macy's and Nordstrom charging 32% APRs for retail cards.
• Historical context on rising credit delinquencies.
• Best Buy's quarter and sales slowdown.

Plus Motley Fool personal finance expert Robert Brokamp and contributor Matt Frankel discuss what to do if your consumer debt is getting more expensive.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Aug. 29, 2023

Ricky Mulvey: You love to see an all-time high, except when it involves credit card debt. You're listening to Motley Fool Money. I'm Ricky Mulvey. Joining us now is Bill Barker. Bill good to see you.

Bill Barker: Good to see you.

Ricky Mulvey: Well, Best Buy reported earnings this morning. Always get a chance to see the appetite for those big ticket purchases. Also completing the earnings triple sales beat expectations, the company lowered guidance and the very first analyst question was about artificial intelligence. Best Buy is seeing a drag from appliances down 16%. But Bill, anything stand out to you about the consumer electronics retailer's quarter?

Bill Barker: Well, they've been essentially in a little bit of a micro recession. For Best Buy of course, that's attributable to the fact that a lot of in-home electronics and appliance purchases were made in the 2021, 2020 era so a lot of sales were pulled into those years. The last two years you've seen a decline in sales which is really returning the company back to a normalized level. In terms of the little bit of a bump up-today in the stock price, that's mostly attributable to company saying that it sees a light at the end of the tunnel. There'll be continued declines this year from last year and last year sales were down about 10% for the company as a whole, but they see next year maybe showing a little bit of growth. That's enough to make the market happier this afternoon than it was last night.

Ricky Mulvey: About a 5% rise this morning. CEO Corie Barry would very much like investors to focus on those upgrade cycles, saying, "Natural upgrade and replacement cycles in the normalization of tech innovation has basically pulled forward demand," which they are now at the bottom. And I don't know, I think there's also a consumer debt story that might be playing out with this company that they are not addressing. What say you?

Bill Barker: I think at the margin maybe a little consumer debt situation although consumer debt while certainly up from where it was at the bottom when everybody was buying from Best Buy and a few other places that were celebrating everybody staying at home, I think that that is a little bit of a headwind in terms of people taking down their discretionary spend on goods. There's still, the discretionary spend is more catching up with all those vacations and travel plans and experiences that have been forgone for a couple of years. I think it's a headwind but the economy is in reasonable shape. Consumer debt is certainly higher than it was but not high by historical means.

Ricky Mulvey: Let's get into that in a sec. But Best Buy is basically signaling that they are at the bottom of a cycle especially with those computers and cellphones, that kind of thing, pays about a 5% dividend and trades below a market multiple. Do you think that this is worth a look for investors who like to play cyclical games?

Bill Barker: Well, the stock is not at the bottom of the cycle, it's about where it was five years ago. As you mentioned, they pay a reasonably healthy dividend, a little bit North of 4% on the yield right now, and they take their extra money and both pay the dividend and knock down their shares. They've done a pretty good job of buying shares back. So it's not a growth story as a whole for the company. It's probably going to do a little bit less this year than it was doing in 2019 in terms of the fiscal year total sales. So it gives you a little dividend, you're buying back shares, maybe that pumps the earnings per share up over time. Certainly knocking shares down to about 225 million from 300 million in the last five years is they're buying back shares at a below market rate which is I think what they should be doing rather than trying to grow in a retail situation that is not really going to help them out too much.

Ricky Mulvey: Also on a little bit of defense with shrink, Corie Barry in the earnings call addressing how they are focusing on that, you can imagine that might be a problem for an electronics retail company basically saying that they're pulling off a lot of these, they called it, items that are more susceptible to shrink off the floor and replacing those with more endcaps. Be interesting to see it how they address that moving forward.

Want to move on to this consumer debt story though, which I think is something I'm watching with the overall academy and I don't know how it ends but I think it could be significant for some of the companies we watch. Three things. One is that credit card debt hit an all-time high of about a trillion dollars this quarter. Credit card interest rates also hit an all-time high of about 20% which is up from 15% about a year ago, and there is another 1.7 trillion in student loan debt that is about to come back online. We like the bottom-up investing stuff focusing on companies and in their future earnings, but is this macro stuff? Is that meaningful to you as a stock investor?

Bill Barker: Well, the headline that credit card debt is both passed $1 trillion and is at an all-time high is in on its own problematic. That is, as the economy grows and in terms of inflation driving the nominal price of one trillion dollars, that's a nominal figure, you would expect credit card debt to keep growing over time as the economy grows and as the population grows and as inflation kicks in a little bit of a tailwind on that nominal number. I'm not sure that is yet at a real all-time high. Certainly in terms of credit card delinquencies it's nowhere in the vicinity of the all-time highs which were back in 2008, 2009 era. It is returned to what you might call a normalized rate. Delinquency rates are 2.77% according to the St. Louis Fed for the end of last quarter and that's right about where they were in 2019, 2.6%. That's up off the floor. The delinquency rates were very low two years ago and they are up. The trend is not good. If it keeps going up from here, that is going to be a big headwind especially for discretionary spend.

Ricky Mulvey: Some retailers are already noting it. Macy's, noted that they had, "increased rate of delinquencies within the credit card portfolio across all stages of age balances" within their latest quarter. Nordstrom which also charges a similar APR for their credit cards said they saw revenues rise in the first half of the year but its gearing up for more delinquencies. I don't know. I think this might just be a self-inflicted wound for these retailers though, what you're charging like a 32% APR. I don't know. You tell me, is this maybe more of an isolated problem for those retailers?

Bill Barker: Well, yeah. It is quite usurious rate. They pay their loans practically. I think that they're taking on lower credit quality accounts and that is going to come back to bite them. Who it really bites are those people who can pay off these credit cards and are unaware of the astronomical rates that are being charged that you actually want to pay this thing off first even if your student loan seems like it's more important. But people default to the student loan, to the mortgage, to the things that are more their car. Much lower rates in all those categories, but they seem more important so they get paid first when people are making some of these decisions. It's incredible that they can get away with rates like that. But they do and that helps the business and that has been a part of the business for a long time.

Ricky Mulvey: One of the reasons I think they get away with it is because they don't really make it visible. I use the Discover card and before this recording I was like, well, I should check what my APR actually is. Then essentially you have to double-click on your statement, go-to a month and then go down to page 4 where it will actually tell you what your APR is. I think this might be a problem. Is a lot of people don't know what they're paying and these companies aren't exactly eager to tell them right up front.

Bill Barker: Absolutely the case. The Motley Fool has been singing the song of pay down your credit card balances and know your APR for the entire history of the company and things don't really change in terms of consumer education about these issues. But it's an opportunity for the credit card companies and they've maximized it. These rates are findable, but as you pointed out, they are not obvious.

Ricky Mulvey: Discover is getting plenty of grief with their regulatory missteps. A very quick exit for their CEO. They are also expecting those delinquencies to normalize to pre-pandemic levels. They're counting it at about 3.5%. Do you think there's a disconnect between these more, I would say, larger credit card issuers and these more specialty retailers that are charging as you would say, the usurious rates?

Bill Barker: Well, it's not as if 20% in that ballpark is all that much better than 32%. Discover is doing well as a whole despite the regulatory issues just because these have grown. These interests accounts have grown. That's I think 70% of Discover's business is the interest off of credit card balances so it's good times for them.

Bill Barker: If they can keep delinquencies below as they still are, the 2019 rates and the balance is up and the rates up, they do pretty well, but there's a danger that things get out of hand. Delinquency rates were typically for even 5% for the '90s and the early 2006 peaked almost during the worst part of the Great Recession closer to 7%. At below 3%, we're a long way from those days. The economy is in good shape. Some people will carry a credit card balance and it's the job of Discover and others to make sure that the right people, that is the people who will keep a balance but pay it off, never pay it off, but always be paying off enough of it are the ones that are the customers rather than the ones who just never end up paying.

Ricky Mulvey: Bill, I'm taking my hand off the panic button done. I was doing research. I was going down a rather dark rabbit hole on how this story could end. I appreciate your realism and your optimism on this.

Bill Barker: Well, if you just look at the last two years, three years, that the chart for delinquency rates will alarm you. But if you look at the last 35 years perspective, we'll call you.

Ricky Mulvey: One and out, zoom out. Bill Barker. Appreciate your time and your insight.

Bill Barker: Thank you.

Ricky Mulvey: That's consumer debt from the investment side, Robert Brokamp and Matt Frankel continue the conversation with some actionable advice. If you've been carrying some credit card or student loan debt.

Robert Brokamp: Federal Reserve has been hiking interest rates since March of 2022 and the cost of our money has risen right along with it. There were hopes that the Fed would slow down and rates would moderate this summer, but instead, rates began to spike upward toward the end of July and into August. Here to help us sort through what's going on and what consumers could do about it, it's Motley Fool contributor Matt Frankel, certified financial planner and a loan expert at the Ascent Motley Fool website. Welcome Matt.

Matt Frankel: Hey, thanks for having me. I wish we were talking about rates going down, but that's obviously not going to be the case for a little while now.

Robert Brokamp: That's true, that would be happier news. Matt, what's your take on this late summer jumping rates? Why is it happening?

Matt Frankel: Well, it looks like one, inflation is a little bit harder to control than the Fed had expected. Number 2, it's just the Fed seems to be willing to be a little more aggressive than the market expected they would be. We all know that consumer interest rates, especially those that are not directly tied to the federal funds rate are more based on expectations than what the Fed is already done. The expectations have increased and so have mortgage rates and auto low rates and all that good stuff unfortunately.

Robert Brokamp: Yeah, another thing going on too is that when we look at the beginning of the year, many people expected a recession, either this year or next year. If you think a recession is coming, then you go in and you buy bonds, which drives up prices and lowers rates. But people are thinking, you know what, we might manage to pull off this so-called soft landing, which means people are starting to sell some of their bonds, driving up rates. The 10-year yield now is the highest. It's been since 2007. You have all that together and you see rates of all types going up. Let's get into some individual types of loans starting with perhaps the biggest for most people. That is a mortgage. Thirty-year mortgage rates around 7.4%. That is the highest level in 23 years, pushing mortgage demand from homebuyers to the lowest level in 28 years. Matt, what's your take on the mortgage market these days?

Matt Frankel: Yes. There's a lot to unpack there. It's not just the rates are higher and home prices are higher. That's making mortgage demand drop. They're making homes on affordable for sure. But there's always people who need to buy homes. People get transferred for their jobs. They can't rent for one reason or another. I have two large dogs, for example, a pet friendly rental is tough to find in a normal housing market right now. A lot of people need to buy homes for one reason or another. But you're also seeing a lot of people stay in place who otherwise would move, which is creating a historic lack of supply. Supply is actually the lowest on record right now in modern times. The reason is a lot of people like me, my mortgage rate is 3% flat. I'm not going to give that up and take a mortgage that's 7.5% if I want to go somewhere else, but going to wait it out until rates start to moderate. You're seeing that happen all over the place. For the first time in a long time since the Great Recession, it's become a lot more affordable to rent homes than to buy homes in the United States. It's a pretty big difference now rent has risen, but not to the extent that mortgage rates and rising home prices have pushed up the cost of ownership. You're seeing it's more affordable to rent. A lot of people are deciding to rent for a while and stay put or keep their options open. You're seeing a lot of homeowners stay put, which is limiting the supply on the market.

Robert Brokamp: Yeah. It's something like, I don't know. It's like it more than 80% of current mortgages are below 5% and 60% or below 4%. Those people are not going to want to move anytime soon. Mortgage rates are higher than you would think they would be normally. The difference between the 10-year treasury and 30-year mortgage rates is like 1.5% to 2%. But today it's 3%. Something else is going on could be the greediness of the banks, which we might get into a little bit later too. Yes, home affordability is very difficult. Difficult to get a reasonably priced mortgage. What should people do right now?

Matt Frankel: Well, if you need to buy a home, I would suggest looking at the new homebuilders because they've some relief from these issues. They have not unlimited inventory, but they have the ability to create inventory which the private market does not. They also have the advantage that they can offer what everybody wants, which is lower mortgage rates in a lot of cases. One builder, I know these are called rate buy-downs. Essentially, the builder is paying the bank to give homeowners better rates. It's being baked into the home price. But people see that you can get a 5% mortgage rate through a new homebuilder or one builder in particular, I know is offering a 5.99% permanent rate and buying down to 3.9% for the first year, keeping people's initial payments low. People in their mind they're thinking, I get to 3.9% for a year. Eventually rates are going to drop, I'll refinance. This sounds like a great deal. In a way it is. I would say if you need to buy a home, definitely check out some of the new homebuilders because they're offering some pretty nice incentives right now. They've realized that this is a very homebuilder favored market. If you can wait, it might be a good idea to wait, especially if you can rent and have an affordable living situation for a while. The mortgage market right now is tough. The home-selling market has slowed to a crawl in most markets in the US and I don't know if that's going to change anytime really soon.

Robert Brokamp: Yeah. I'll just double-click on your renting versus owning. It can be much more affordable. You'll find calculators online that will help you do the math, but do not underestimate the maintenance costs of owning a home. By the time this summer is over, the Brokamp household will have spent over 15,000 tellers on repairs at our home. You can't really predict those things. But it's something that I think a lot of people don't appreciate in terms of the overall cost of owning a home.

Matt Frankel: That's another thing with new homes, you've less of that maintenance expense. Not good. It's still unpredictable to some degree. It can help alleviate that variable expense.

Robert Brokamp: Very good point. Let's move on to another type of debt and that is credit cards. According to creditcards.com, the average rate on our credit card is 20.9%. According to LendingTree, the average rate is now 24.4%.

Robert Brokamp: These are all-time highs, and lenders keep pushing them higher. So considering that credit card rates are generally based on the prime rate, which is currently 8.5%, and that's the highest level since February of 2001. Back then, the average credit card rate was less than 16%, much lower than the current average rates of 21-24%. Matt, what the heck is going on here?

Matt Frankel: Well, it's not just about what the prime rate is. That's what dictates the variable credit card rates. That's why your credit card rates have risen by about 5% in the past couple of years because the prime rates directly tied to the federal funds rate. And you're seeing that rate rise as well. It also has to do with lender perceptions of the economy, right? If lenders see a recession coming, that's an added credit risk. A lot more people could be in default, they could have trouble keeping up with their bills, things like that. So they will adjust their new interest rates according to how they see the economy and how they perceive risk. If the average person is taking on more credit card debt, I saw credit card debt recently topped one trillion dollars in the US for the first time ever, and that's a risk factor to lenders. If people have more debt, more people are going to get in over their heads. If we see unemployment start to rise, which it probably would in a recession, we really haven't seen a spike in unemployment yet, like a lot of people thought we would. But in lenders minds, that's a risk, and rightly so. It's never a good idea to borrow money at 24%, but hopefully, if we see rates go the other way, we'll see that turnaround a little bit. The average credit card rate was 17%, not that long ago, so it's cyclical.

Robert Brokamp: Yes, we can hope. We can hope, right? So for those people who are among the contributors to this one trillion dollars in overall credit card debt in the US, you have a balance, what should people do about it?

Matt Frankel: Well, surprisingly, credit card companies have been raising their interest rates, and they've been raising naturally with the federal funds rate. The 0% APR introductory offers are still surprisingly common. It's surprisingly easy to get a card that will give you a 0% APR for, say, 18 months on balance transfers. If you have credit card debt, and you are tired of giving 24% interests to a bank every year, one of these offers could be a good way to help you get out of debt. Because then at least every penny of your pay, your credit card issuers going toward the principal, not interest. So that's one option right now. The personal lending market has really exploded in the past five or six years. There's never been more competition against personal lenders. That's a good thing for people who owe money, because the primary use of personal loans is debt consolidation, getting rid of credit card debt and things like that. And the average personal loan interest rate is something in the 13-14% range right now. Not fantastic by any means, but definitely better than a 24% APR you're paying on a credit card, and they have higher but set monthly payments. So it could be a nice way to plan your way out of debt and avoid the minimum payment trap on credit cards, which a lot of people get themselves into.

Robert Brokamp: All right, let's move on to our third and final type of debt, and that is student loans. So after three years of a pause on student debt payments, interest begins once again accruing on September 1st, in other words, this Friday, and payments resume on October 1st for 44 million Americans. So the rates range from basically 5-8 percent, but up to 15% depending on the borrower and whether the loan is from the government or a private bank. Matt, what can borrowers do to manage their student debt payments?

Matt Frankel: Well, first of all, I consider federal and private student loans completely different types of debt. Almost nothing in common. A private student loan is essentially a personal loan. It's a personal loan that you can't get rid of through bankruptcy is really the only difference. With federal student loans, they're actually one of the lower-interest forms of debt you can have. And they're probably the most flexible type of debt you've had, and that's about to get even more flexible. For number one, the student loan payment, I'd call it a soft restart. They've already announced that it's going to be a 12-month on-ramp to reach restart payments that will last through September 2024. So that means if you can't afford your payments, and you don't make payments right when payments restart, technically you're missing payments, but they won't be reported to the credit bureaus. No adverse effects will happen for the first year. So the administration is telling you to start repayments if you can afford it. But if you can't afford it, and you need a little extra time, it's not going to count against you for the first year or so. That's number one. Number two, they're launching what's called the SAVE plan. This is replacing what's called the repay plan, which is the most popular income-driven repayment plan right now, and it's designed to lower people's payments significantly to eliminate the accrued interests trap. We've all heard the horror stories of someone who borrowed $80,000 to pay for their undergraduate master's degree has been paying on their loan for 10 years and now owes $90,000. That's because in a lot of cases that payment doesn't cover the interest that's building on the account, and it's tacked onto the balance. The SAVE plan eliminates that, and it also sets an easier path to loan forgiveness. Twenty years of on-time repayment for undergraduate loans, and that's actually reduced to 10 years in repayment for loans that had original balances of $12,000 or less. That's decided to essentially make community college a lot more affordable. So the action plan is to apply for the SAVE plan. If you're already enrolled in the repay plan, you will be automatically enrolled. But do that if you haven't done that. Or if you're not enrolled already, find out who your loan servicer is. Because a lot of people don't realize, the three biggest loan servicers for federal student loans exited the business during the COVID pause. I know mine is different. Your loan servicer is not likely to be who it was before, and student loan refinancing is not as good of an option as it was before the payment pause. You used to be able to get a student loan refinancing through some of these private companies like SoFi or Discover with a 3% interest rate. That's not the case anymore. You're not likely to really save a lot of money, and you're losing all that flexibility that comes with federal student loans.

Robert Brokamp: Yeah, so some features of the SAVE program take effect immediately, others not until next July. So definitely look into it. The best source of information for all this is studentaid.gov. The SAVE program is open. I think they opened it last week. And as you might expect, the service loan providers and the Department of Education have been swamped with calls and stuff like that. So it is definitely a good idea to take care of this sooner rather than later because it's just going to get more complicated as time goes on. All right, Matt, so do you have any final thoughts on what's going on in the borrowing market these days and what people can do about it?

Matt Frankel: Yeah. One thing that's more important than ever, not with student loans, but with all these other types of debt, is to shop around. When it comes to mortgages, when it comes to auto loans, which we really haven't talked about but are in the same boat, essentially. One, it's easier than ever to check your rates from different lenders. A lot of lenders will even let you check your rates without a hard credit poll, even in the mortgage industry. So it's easier to check your rates than ever, and there's a provision in the FICO scoring formula that encourages rate shopping. You can apply for a dozen mortgages as long as you do it within a normal shopping period, which is considered about two weeks, it won't count against you other than just a single loan application. So rate shopping, you have very little to lose other than maybe a couple of hours and your time. And you'd be surprised at how much you can SAVE by getting, say, a 7% mortgage rate as opposed to 7.1. It's a big difference over time. Shopping around matters more than ever, so I would definitely encourage anyone who needs a new car or a new house or anything to do that.

Ricky Mulvey: As always, people on the program may have interests in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy yourself stocks based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll see you tomorrow.