02/28/2014 09:00 pm ET | Updated Apr 30, 2014

The Great Debt Shuffle

Recent changes in household balance sheets can be viewed as a glass half-full or half-empty. But there are some traps lurking behind an apparent reduction in overall debt.

The good news on household balance sheets is that there is much less mortgage debt outstanding than there was a few years ago. The amount of residential mortgage debt outstanding has dropped by nearly $1.5 trillion since peaking at $11.3 trillion in early 2008.

The shifting of debt

This lightening of the mortgage burden has been widely trumpeted as a triumph for the Federal Reserve's quantitative easing program that drove mortgage rates to record lows, and for special government programs to help people refinance. What is less celebrated is the fact that the reduction in mortgage debt outstanding is also partially due to the rash of foreclosures that the Great Recession brought on. Foreclosures take away the mortgage debt, but unfortunately, they also take away the house.

There's something else that takes a little luster off the accomplishment of reducing mortgage debt: Over the same time period, Americans have been ramping up consumer debt such as car loans, credit card balances and student loans. So, while mortgage debt has dropped by nearly $1.5 trillion, these other forms of consumer debt have increased by almost $0.5 trillion. That may still sound like a net victory for debt reduction, but in the long run these other forms of debt may prove much more difficult to manage than mortgage debt.

Disadvantages of non-mortgage debt

Here are four reasons why the growing pile of non-mortgage debt is harder to handle than mortgage debt:

  1. Higher interest rates. Mortgages, being backed by a tangible asset, generally have lower interest rates than these other forms of debt. In other words, to some extent people are replacing mortgage debt with more expensive obligations.
  2. No interest deduction. The interest rate advantage of mortgage debt is enhanced by the fact that mortgage interest is generally tax-deductible, while interest on those other forms of debt generally is not.
  3. Much shorter repayment terms. Most mortgage debt is stretched out over a 30-year repayment schedule. In contrast, car loans, credit card debt and even student loans have to be repaid in a much shorter period of time. So, while people may have reduced their overall debt burdens, they will have to meet those obligations much more quickly.
  4. Faster interest rate rollover. Today's debt is being taken on at a time of unusually low interest rates. Most mortgages lock in those rates for a period of 15 or 30 years. As other debt comes due more quickly, Americans may find that the next time they have to borrow it will be at significantly higher interest rates.

In short, while American households have reduced debt in recent years, they are also increasingly shuffling debt into harder-to-handle forms. This will become more and more of a problem as people re-inflate their total debt burdens back to prior levels, which seems inevitable: In the third quarter of 2013, mortgage debt outstanding increased for the first time in more than five years. It seems the great debt shuffle may prove to have been more of a song and dance than a substantive solution to this country's debt problems.

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