Recent changes to a measure of U.S. household debt service

Federal Reserve Bulletin, Oct, 2003 by Karen Dynan, Kathleen Johnson, Karen Pence

The Rise in Homeownership and the Homeowner Financial Obligations Ratio

The increase in homeownership over the 1990s appeared to stem in part from changes in the mortgage market, as the mortgage industry became more sophisticated at developing products for borrowers with impaired credit or with limited funds for a down payment. If these new homeowners, who would have been renters in the past, have high debt levels relative to their incomes, the homeowner FOR will increase. However, this increase will not signal that existing homeowners have taken on more debt; it will reflect simply the changing composition of the homeowner pool.

The effect of this rise in homeownership on the homeowner FOR cannot be precisely estimated because we have no way of identifying current homeowners who would have been renters under the prevailing lending standards of the past. However, recent research by Federal Reserve staff suggests that the increase in homeownership over the 1990s was concentrated among households with limited funds for a down payment.(18) As a rough attempt to quantify the magnitude of this new-homeowner effect, we isolated the new homeowners in the 1995, 1998, and 2001 Surveys of Consumer Finances with the largest mortgage loans relative to their house values. For each of these waves of the SCF, we chose enough of these households so that, when they were removed from the homeowner group, the homeownership rate would be reduced to its 1992 value.

Removing these new homeowners from the homeowner group subtracts about half the growth in the homeowner FOR over the 1990s (chart 5). This change may be an upper bound on the magnitude of the effect because we removed from the homeowner pool some of the households with the highest levels of debt. Indeed, excluding these households decreases the debt service payments of homeowners 11 percent, whereas their income decreases only 4 percent. This estimate suggests that the rise in the homeowner FOR over the 1990s reflects an increase in both the indebtedness of homeowners and in the rate of homeownership.

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SUMMARY

Recent changes in financial markets have necessitated changes to the structure and the methodology of the debt service ratio statistics. The new household financial obligations ratio, introduced in this article, adds rent, auto lease payments, and other recurring obligations to the household debt service ratio. Both the new household FOR and the revised household DSR incorporate an expanded measure of consumer credit and revised estimates of loan maturities and interest rates. The new FORs for homeowners and renters provide separate estimates of the indebtedness of these groups relative to their respective incomes.

On net, these changes in methodology have raised the level of the DSR but have not substantively changed its trajectory over time. As was true before the revision, the DSR in 2002 was similar to the peak level reached in the 1980s. The homeowner FOR, like the aggregate FOR, increased gradually during the 1990s, whereas the renter FOR rose more steeply. However, both the homeowner and the renter FORs have remained largely unchanged over recent quarters. Homeowners appear to have managed their liabilities through the recent period of economic weakness by rebalancing their portfolios toward lower-cost mortgage debt.