What Would Happen if We All Paid Off Our Debt?

It's no secret that consumers are saddled with debt. Combined, in the United States, individuals owe more than $12.6 trillion dollars. Since approximately 24 percent of households are debt free, and there are around 114 million households in the U.S., the average household is saddled with?

Sit down.

Approximately $145,000 in debt!

I'm about to combine averages and medians for simplicity's sake, but bear with me: According to the Census Bureau, median household income is $51,881 per year. If the average household did nothing but pay down debt, it would take 2.8 years to pay it all off!

Naturally, it's absurd to expect an entire household's income to go to debt. Even if 30 percent of the income were dedicated to debt payoff, it would take 9.32 years.

That seems like a long time.

However, let's think about the ramifications. If we, as a society, buckled down and committed to paying off debt. What would really happen?

The economy would slump. Consumer spending is roughly 70 percent of GDP.. Since, according to the Federal Reserve Bank of St. Louis, the savings rate is currently 3.7 percent, increasing the savings rate--a corollary to paying off debt--would mean a decrease in spending by 26.3 percent. Because of the decrease in spending, there would be a significant round of layoffs, which would contract the economy further, decreasing household incomes, and probably increasing the time it would take to work through all of our consumer debt. According to Jerry Pace, president of the Crowley business division of Texas Exchange Bank, "We must first identify what the root problem is in the economy...and then basically stop digging when we have dug ourselves into a hole."

Banks would have to figure out another way to make money. Since the essential tradeoff for a bank is to take deposits, pay you a deposit rate, and then loan the money at a higher rate for a profitable spread, banks would need other income sources. Banks can currently offer interest-bearing deposit accounts, free checking, free bill pay services and other "perks" because they can profitably lend that money which you give them to borrowers while making money for themselves. Banks would have to charge to hold your money, and CDs and money market accounts would disappear. No more free toaster when you open up your Christmas passbook account.

The housing market would dry up. Since people would have to save money to buy homes with cash rather than using a traditional mortgage, demand for homes would drop drastically, and demand for rental housing would increase significantly. The construction industry would plummet, since few people could afford new homes.

The same holds true for the auto industry, although the drop would not be nearly as dramatic. Still, automakers would shift their production from non-economical SUVs to more economical and less expensive cars to provide them at a much lower price point.

Do-it-yourself providers would bloom, as people would find ways to save money through doing things themselves. Have trouble parking at your local Lowe's or Home Depot now? Just wait until this national get-out-of-debt program kicked in!

Restaurants would suffer, as people would choose to eat at home to save money.

Enrollment in universities would drop. Smart universities would lower their tuition rates to make them affordable for families and for college students who worked their way through school.

Community colleges and technical and vocational schools would thrive, as students choose educational courses and vocational skills in careers where they could earn a good living.

That's not to say we haven't lived more frugally in the past (or, that Americans are actually cutting spending that drastically). Credit cards, for instance, didn't even exist before 1946. Mortgages have been around since the Middle Ages, but it prior to the Great Depression, it was common practice in the U.S. to have a 50 percent down, 5-year interest-only loan. So, living in a relatively debt-free society is not an uncommon phenomenon in our history.

Once the time of paying off our debt passes, we would ring in a new era of prosperity. Rather than having so much of our income burdened by interest and paying for past purchases, we could free up that income to save for retirement, spending, and giving. We could take more risks and be more entrepreneurial, as we wouldn't have mortgages, car payments, and student loans to worry about if our entrepreneurial ventures did not succeed. The country's net economic power would increase as more money was spent on goods and non-financial services--production rather than monetary intermediaries. We would be back to being able to consume what our country's economic capacity could produce.

One in four of us live that way today. Just imagine what would happen if the other three joined us.

Jason Hull is a candidate for the CFP(R) Board's certification, is a Series 65 securities license holder, and owns Hull Financial Planning.