The heterogeneous reactions of household credit to income shocks

We examine how household debt portfolios, aggregated to the ZIP code level, respond to local income shocks. Using a Bartik-style instrument for persistent income changes and a novel instrument based on shale oil discoveries for transitory shocks, we document that households, on aggregate, use positive income shocks to pay down debt. However, this aggregate response masks a stark bifurcation in financial strategy. The main point of consensus is high-interest credit card debt, which nearly all households prioritize repaying, but the divergence is most pronounced for mortgages and auto loans. Specifically, the deleveraging of total credit is driven by financially healthier households—those with high credit scores, high incomes, or low leverage—who aggressively target consumer debt via credit cards and auto loans. In contrast, financially constrained households often use the income windfall as a gateway to new auto credit, while simultaneously showing a strong propensity to pay down their largest liability, the mortgage. Our findings highlight that an income shock triggers balance-sheet repair for some and relaxes borrowing constraints for others, calling for more nuanced policy approaches that account for this deep heterogeneity.