Families took on more debt in late 2011 for the first time in 3-1/2 years but a rise in after-tax incomes left consumers in better shape to spend.
Other data on Thursday showed the number of Americans filing for jobless benefits rose last week, but not enough to change perceptions the labor market was strengthening.
The economy is still limping back from a financial crisis that wreaked havoc on household finances and put millions of people out of work.
However, rising incomes eased the pinch in the fourth quarter. The ratio of household liabilities to after-tax income - a broad measure of the debt burden - fell to 117.5 percent, its lowest level since 2004.
Economists are unsure how much more that debt burden must decline for consumers to feel normal again, but Thursday's data pointed to progress.
Any little inroads we make bring us that much closer to getting back to a normal rate of consumer spending, said Ellen Zentner, an economist at Nomura in New York.
In a separate report, Labor Department data showed initial claims for jobless benefits unexpectedly rose last week to 362,000. Still, new claims remained near the four-year low reached last month.
You are bound to get some uptick even when the overall trend is downward. The labor market is improving, but it's still quite impaired, said Paul Edelstein, an economist at IHS Global Insight in Lexington, Massachusetts.
A closely watched report on employment on Friday is expected to show solid job growth in February and could reduce chances of more monetary stimulus from the Fed, which meets on Tuesday.
The government is expected to report the economy added 210,000 new jobs last month, according to a Reuters survey.
THE WEALTH EFFECT
U.S. financial markets largely ignored Thursday's data, with traders taking their cue from developments on Greece's efforts to get private creditors to join a bond-swap deal.
With labor market conditions improving, Americans appear more willing and more able to take on debt.
Consumer credit swelled by 6.9 percent during last three months of 2011, the Fed said. It was the biggest gain since the same period in 2001 when credit was surging in the wake of the September 11 attacks in New York and Washington.
Other reports have shown that much of the recent surge in borrowing has been to buy cars and pay for college.
In the fourth quarter, the Fed's report showed households continued to shed mortgage debt, which declined at a 1.5 percent annual rate. That was the smallest drop in two years, suggesting Americans were closer to recovering from the debt hangover left by a burst housing bubble.
It also showed household wealth increased by $1.2 trillion, with a drop in the value of real estate tempering gains from stocks.
The extra wealth could lead consumers to spend more, especially if home prices bottom out, as some analysts expect.
The combined wealth effects from financial and housing assets (will likely) begin lending increasing support to consumption growth as the year progresses, Troy Davig, an economist at Barclays, wrote in a note to clients.
Still, families have struggled to rebuild their net wealth after the country's housing bubble popped and triggered the last recession. Household net wealth in the fourth quarter was still about 13 percent below its peak in the second quarter of 2007.
(Editing by Neil Stempleman)