By Leah Schnurr
NEW YORK (Reuters) - As Dawn chips away at paying back her $18,000 debt load, the 45-year old swears she'll never use credit again.
Like many Americans bruised by the recession, she says she has changed her lifestyle for good.
That may be positive for the long-term health of the economy but poses a challenge for policymakers trying to get it to grow again.
When Dawn's husband got a promotion three years ago, they moved the family to Georgia from Florida, using credit cards to pay for the expenses and adding on to their existing debt amount.
They had expected a pay raise and bonuses would cover the bills. Within six months, Dawn's husband had been laid off.
"The late charges were coming on the cards and the interest rates were being jacked up," said Dawn, who asked that her last name not be used to protect her privacy.
"I was having that moment of panic like, 'Am I going to claim bankruptcy?'"
Dawn eventually got help from credit counseling firm Take Charge America. It negotiated down her rates and worked out a payment plan. She has paid off two-thirds of her debt and the family lives frugally, saving for the two children's Christmas and birthday presents but foregoing former luxuries like spontaneous trips to the mall.
"I know that I will never depend on credit again. There is nothing more exciting to me than the prospect of being out of debt," said Dawn.
As governments in many developed economies struggle to reduce their own swollen budgets, consumers such as Dawn have spent the last three years tightening their own belts by paying off debt, saving more and spending less.
Financial prudence comes with a price for the economy and partly explains why the recovery has been so sluggish. Spending growth has been much more modest than normal coming out of a recession, especially with interest rates so low.
With consumer spending accounting for two-thirds of the economy, recent fears the United States is headed for another recession have intensified efforts to put more money in the pockets of Americans and get demand growing again.
President Barack Obama announced his latest stimulus proposal on Thursday that he hopes will give consumers some extra cash to spend.
Yet it remains to be seen whether Americans will use the planned lower payroll taxes to buy more goods and services or instead plow the money into paying off their debts.
Household liabilities in the United States ballooned to about 135 percent of disposable income in 2007 -- just as housing prices were starting to slide in what would become the harbinger of the global credit crisis.
The rate has been falling almost steadily since then and was 119.3 percent in the first quarter, according to data from the Federal Reserve.
Economists say that trying to find a "healthy" level of debt means little when so much uncertainty about the prospects for the economy are weighing on spending.
CREDIT BINGE LEAVES UGLY BILL
The 2000s were halcyon days for consumers. Credit was easy and surging home prices allowed Americans to tap extra cash from their homes.
Once those factors vanished in the credit crisis, consumers were left with an ugly bill.
"It's almost like at that point you saw people sitting around the kitchen table saying, 'Hey, we can't live like this any more,'" said Mark Cole, executive vice president of CredAbility, a nonprofit credit counseling and education firm.
The household debt service ratio, which measures debt payments against disposable income, fell to 16.4 in the first quarter of the year, its lowest level since 1994, according to data from the Federal Reserve.
It is well off the peak of 18.9 hit in the third quarter of 2007 as housing prices were collapsing.
While balance sheets are looking better, a significant amount of that is due to Americans walking away from their mortgages and credit card debt.
The default, or "charge-off", rate on consumer loans was a seasonally adjusted annual 4.5 percent in the first quarter, according to data from the Fed. That is down from a peak of 6.7 percent in the second quarter of last year, but is far higher than the 2-3 percent range seen at the start of the 2000s.
"The red flag is we're seeing people pay down debt, but still an overwhelming amount is coming off of default and foreclosure activity," said Beata Caranci, deputy chief economist at TD Bank Group in Toronto.
Yet economists say getting consumer spending back on track is less about debt levels falling to a specific amount and more about bolstering confidence that things are getting better.
"People need to be convinced they're going to have their job in six months and that they're going to be enjoying income gains," said Gus Faucher, director of macroeconomics at Moody's Analytics.
"They need to have that confidence to be able to go out and spend."
Unfortunately for the U.S. economy, consumer confidence recently sank to a near 30-year low, as measured by the University of Michigan/Reuters consumer sentiment index.
"Realistically, this is a multi-year process. This isn't something where December 2012, we're there," Caranci said.
A big chunk of the spending that is happening is by better-off consumers who feel more stable in their jobs and have seen some of their wealth recovered by the rally in the stock market.
Same-store sales at upscale retailers Saks and Nordstrom Inc rose more than 6 percent in August, while sales fell at J.C. Penney Co Inc and Kohl's Corp which cater to more middle-class shoppers.
Experts say how long this lasts depends on whether a deep psychological shift has taken place, in the same way the Great Recession of the 1930s turned a generation into savers.
"Until people get optimistic about the future, it's unlikely that they're going to take longer-term risk," said Cole from CredAbility. "In my mind, this change is going to be lasting for an awful lot of consumers out there."
STILL STUCK IN THE DEBT PURGE
Looking at the historical pattern, consumers could spend a few more years paying down their debt.
The McKinsey Global Institute has estimated that deleveraging of total debt levels in an economy can last about five to seven years after a financial crisis.
Two to three years after an initial downturn, the economy continues to decline as debt levels are worked off, McKinsey said in a 2010 report. In years four and five, there's usually an economic bounce-back despite ongoing deleveraging.
"In historical episodes, that total process of deleveraging can take five to seven years, but the first period of that, which is two to three years, is the most difficult," said Charles Roxburgh, a director at McKinsey.
"You could argue the U.S., on the consumer side, is well into that process, but we also argued...that given the scale of the challenge for the deleveraging of these major economies, it could take longer this time," said Roxburgh.
The uncertainty surrounding the economy has had its effect on people who aren't in debt too.
Dafne Torres, director of operations at a call center run by InCharge Debt Solutions, another debt counseling firm, is starting to see calls from people who aren't in trouble but want to learn how to budget so they can avoid the pitfalls of their friends and families.
Such clients are "way more aware of the importance of living within your means and not getting into too much debt," said Torres by telephone from Orlando, Florida.
"They're seeing their friends losing their homes, or their friends into a lot of credit card debt, and people have learned it's not the right thing to do," said Torres.
(Additional reporting by Phil Wahba, Editing by Chizu Nomiyama)