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Consumers making progress paring down debt

Five years after the bursting of the borrowing bubble, American households are getting a better handle on their debt.

The latest sign came in reports this week showing that homeowners are doing a better job keeping up with their mortgage payments. So far this year, the number of mortgage holders who are behind by two monthly payments or more has fallen 9 percent, according to TransUnion, a consumer credit rating agency. A separate survey By the Mortgage Bankers Association showed that, despite an uptick, in the second quarter, mortgage delinquencies are tracking lower than this time a year ago.  

The improved mortgage numbers come as American households generally whittle away at debt.

On average American households are now spending 11 percent of their disposable income to pay down all forms of debt, down from a peak of 14 percent in 2007, according to the Federal Reserve. That’s the lowest debt service ratio since 1994.

“We are probably witnessing a shift in consumers’ attitudes towards debt,” said Paul Edelstein, an economist at IHS Global Insight.

That change in attitudes is a mixed blessing for the economy. The borrowing binge of the early 2000s propelled consumer spending and the economy, although it was unsustainable, ending in a financial industry collapse and recession.

Now Americans are building up a bigger cushion of savings, allowing them to better weather a job loss or other financial setback.

But that increased saving is weighing on consumer spending, which accounts for roughly 70 percent of the U.S. economy. Growth in spending slowed to an anemic 1.5 percent in the latest quarter from 2.4 percent in the first three months of the year as households socked away more of their earnings.

So while thrift may be good for individuals' long-term financial health, it could also hold back the recovery.

A lot depends on how consumers manage to whittle down their debt. Much of the improvement has come from a wave of mortgage refinancing, which surged in the second quarter as interest rates sank to record lows. That’s saved homeowners tens of billions of dollars in monthly payments.

Rising home prices are also helping to rescue some of the roughly 20 percent of mortgage holders who are underwater, ore owe more than their home is worth.

Credit card rates are also trending lower -- falling from a peak of 13.78 percent in 2010 on average to just over 12 percent in the first three months of the year, according to the Fed.  In June, consumer credit posted its weakest growth in eight months.

Debt levels are likely to continue to fall over the next three years, said Paul Dales, an economist at Capital Economics.

“Although households' balance sheets appear to be on firmer footing than a few years ago, they aren’t exactly rock-solid, either," he said.

Much of the debt has been eliminated through defaults and mortgage foreclosures. Dales figures that, since the 2007 peak, Americans have reduced their debt by $600 billion, much of that through default. 

The drop in mortgage delinquencies follows the steady pace of foreclosures working their way through the system.

"We’re measuring the speed of that resolution process and this point," said Michael Fratantoni, an economist with the Mortgage Bankers Association. "For someone who is a year behind in their mortgage payments, a slight improvement in the job market is not going to result in a cure for them at this point."

Until the job market improves, and wage growth picks up, consumers will have a harder time paring down debt. The portion of income needed to keep up with debt payments has fallen as personal income has risen by $1.3 trillion due to job gains and increased wages during the economic recovery. Those increases are coming -- but the weak job market is also holding back raises as employers still feel little pressure to increase pay levels.

This week's report on worker productivity helps demonstrate why. Employers are having a harder time squeezing more work out of their existing staffs. Even as recent gains in productivity have slowed, wages have begun inching higher.

“Workers are working harder but getting a little more money as well,” said Joel L. Naroff, chief economist at Naroff Economic Advisors. "But workers, who are facing limited job openings, will also see their incomes grow minimally. That does not bode well for future consumer spending or economic growth."

While consumers are making progress in paying down their home mortgages and credit cards, there is one major category of debt that is still rising: student loans, at roughly $1 trillion and counting.

There are several reasons for the increase. During the recession, many people decided to return to or stay in school because job prospects were so lousy. They were hoping to wait out the recession -- and improve their chances of getting a job when it was over.

Student debt has also increased because of the rapid rise in the cost of college tuition, which is growing far faster than inflation.

All that student debt could help boost economic growth in the long run if it means better-educated workers who earn higher wages. But the burden of education costs is increasingly falling on people who won’t reap the rewards, said Cooper Howes, an economist at Barclays Capital.

Some of the burden falls on students’ parents and grandparents; almost 17 percent of outstanding past-due student loans are held by those over 50, and almost 5 percent by those over 60, according to his research.

The economic return on student loans has also been hurt by higher dropout rates, which also increases the likelihood of student loan defaults, Howes wrote in a recent research note.

“The unemployment rate for those who complete only some college, while still lower than for those with only a high school education, remains significantly above that of college graduates,” he said.

CNBC personal finance expert Sharon Epperson explains how people trying to carve down student loan debt can start to tackle their principal by doing an accelerated repayment.

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