Financial Distress: Why It Matters for Households and the Macroeconomy

Financial distress is a central concept for understanding household well-being and broader economic conditions. But what is financial distress? At its core, financial distress occurs when people struggle to keep up with their financial obligations using their regular income and available savings. This may mean falling behind on credit card payments, missing a mortgage or car loan payment, or relying heavily on borrowed money to cover everyday expenses. In more severe cases, financial distress can lead to default, foreclosure or bankruptcy.

In recent decades, especially starting after the Great Recession of 2007-09, tracking financial distress has become increasingly important for both policymakers and researchers because it could help them understand households’ responses to economic shocks.

In this blog post, I will cover how financial distress matters for everyday life and the broader economy, how it is measured, and how it varies across states.

Why Financial Distress Matters to Households

For individuals and families, financial distress can have immediate and lasting effects on everyday life. Often, one of the first signs of financial distress is being unable to make payments on debt. One immediate outcome is delinquency, defined as falling behind on scheduled debt payments.

Even short periods of delinquency can lower credit scores, which play a critical role in determining access to credit, housing and insurance. Credit scores affect whether someone can rent an apartment, qualify for a loan or secure a reasonable interest rate. A lower credit score can make borrowing more expensive or even impossible, creating a cycle in which financial problems become harder to escape.

For homeowners, the consequences of financial distress can be especially serious. If mortgage payments become unaffordable, homeowners risk foreclosure and the loss of their home. Losing a home can disrupt family stability, children’s schooling and ties to the community.

In extreme financial distress cases, households may turn to bankruptcy as a last resort. Bankruptcy can provide relief by reducing or eliminating certain debts. However, it also comes with long-term consequences, including limited access to credit and lasting damage to one’s financial reputation. In other words, financial distress is not merely a short-term inconvenience but a key determinant of economic security.

How Financial Distress Matters to the Macroeconomy

Beyond its effects on individual households, financial distress plays an important role in shaping the economy. When households’ finances are tight, they tend to cut back on spending. Families may delay major purchases, reduce discretionary spending or avoid taking on new financial commitments. When many households do this at the same time, overall consumer spending declines, which can slow economic growth and lead to job losses. This dynamic played a major role during the Great Recession, when financially stressed households sharply reduced spending.For example, researchers Atif Mian, Kamalesh Rao and Amir Sufi documented that areas with more leveraged households experienced much larger declines in consumption during the 2006-09 housing collapse.

Because of this connection, economists and policymakers closely monitor signs of household financial distress. Rising late-payment rates on credit cards or other loans often appear before the economy weakens more broadly.The March 31, 2025, FRED Blog post suggests that delinquency rates may provide insights into future U.S. economic conditions.

Financial distress also shapes how people respond to changes in interest rates. For households already struggling to make ends meet, higher borrowing costs can worsen financial pressure, while lower rates may provide some relief.For example, researchers Caterina Mendicino, Lukas Nord and Marcel Peruffo’s 2024 VoxEU column suggests that higher borrowing costs resulting from banks’ equity losses reduce low-income households’ consumption more than they reduce that of high-income households.

Measures of Financial Distress

Given its importance, several measures have been developed to capture financial distress, each with its own advantages and limitations. One commonly used indicator is the delinquency rate, typically defined as the share of borrowers or the share of outstanding debt that is past due.

Delinquency rate data are easily accessed, since the rates are observable from household balance sheet data. However, they may miss some early signs of trouble, since many people try to stay current on payments by dipping into savings or cutting other expenses.

Another widely used measure is credit utilization, defined as the ratio of outstanding credit card balances to total available credit limits. High utilization rates can signal early financial stress, even before delinquency occurs. However, credit limits can change over time, and lenders may reduce them during economic downturns, making utilization figures harder to interpret. Other indicators, such as default and bankruptcy rates, capture more severe forms of distress but tend to understate the prevalence of moderate financial strain. For these reasons, it is important to rely on a combination of measures to gain a more comprehensive picture of household financial health.

Distribution of Financial Distress across U.S. States

How does financial distress vary across the country? As the map shows, in 2023, states in the South tended to have higher delinquency rates than those in the North. The states with the highest delinquency rates were Georgia (18.8%), Mississippi (18.4%) and Florida (18.0%).

To get the results shown in the map, I used quarterly balance sheet data from the Federal Reserve Bank of New York Consumer Credit Panel/Equifax and computed the delinquency rate by state. In order to compare delinquency rates with annual income data, I defined delinquent account holders as those with credit card debt that is 30 days or more past due for at least one quarter in 2023.

The states are grouped into five quintiles: Lighter colors represent states with lower delinquency rates, and darker colors represent those with higher delinquency rates.

What determines the level of delinquency? One factor could be the level of income. The scatterplot below displays the relationship between the delinquency rate and per capita income adjusted for differences in price levels across states in 2023. The fitted line shows that these two variables have a negative relationship at the state level. In other words, states with a higher per capita income were likely to have lower financial distress.

Why do we see a negative relationship between per capita income and financial distress? It may be that individuals with higher incomes can save more and can therefore address a financial problem more easily by using their precautionary savings. However, it is important to note that other factors, such as housing price declines, also impact households’ financial distress.

Financial Distress Is an Important Economic Indicator

In conclusion, financial distress is multifaceted, with significant implications for both individual households and the broader economy. It may affect access to credit, housing stability and long-term financial security. Financial distress among households can also influence overall consumer spending levels and can impact how people respond to changes in macroeconomic policy. Looking at how financial distress varies across regions can provide additional insights about household financial health, particularly when household debt is elevated. For these reasons, tracking financial distress remains an important task for economists.

Notes

1. For example, researchers Atif Mian, Kamalesh Rao and Amir Sufi documented that areas with more leveraged households experienced much larger declines in consumption during the 2006-09 housing collapse.
2. The March 31, 2025, FRED Blog post suggests that delinquency rates may provide insights into future U.S. economic conditions.
3. For example, researchers Caterina Mendicino, Lukas Nord and Marcel Peruffo’s 2024 VoxEU column suggests that higher borrowing costs resulting from banks’ equity losses reduce low-income households’ consumption more than they reduce that of high-income households.