Partners (Number 2, 2008)

Growing Consumer Reliance on Credit Cards

Are more lower- and middle-income consumers relying on their credit cards to cope with rising energy and food prices?

cascading credit cards

At one time consumers might have used the option of refinancing their homes or tapping a home equity line of credit to increase cash flow to temporarily make ends meet. But more stringent credit standards and falling home prices have locked many families out of that market. Some experts believe Americans are now turning increasingly to high-priced credit cards as an alternative.

A recent report by the Center for American Progress cites a Boston Globe article that states direct mail credit card offers aimed at subprime customers jumped 41 percent in the first half of 2008 compared to the first half of 2006. During the same time the April 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices conducted by the Federal Reserve indicates that most mortgage lending became more stringent. About 60 percent of senior loan officers had tightened lending standards on prime mortgages and almost 77 percent had made subprime mortgage standards more rigorous.

Related Links
Démos
Center for Responsible Lending
Center for American Progress
New America Foundation

Credit card balances climb
Credit cards, once seen as a convenient short-term loan or as a fallback for emergencies, are becoming increasingly a financial coping strategy. According to the 2007 Démos report entitled Borrowing to Make Ends Meet: the Rapid Growth of Credit Card Debt in America, credit card debt has risen 315 percent between 1989 and 2006.

As of 2006, approximately six out of every ten households using credit cards rolled forward their balances, and 35 million Americans made only minimum payments each month. The median household credit card debt was up from $2,768 in 1989 to $5,219 in 2004, an increase of 89 percent (shown in 2004 dollars). In this period, credit card debt for lower-income households increased four-fold. These households use approximately 40 percent of their income to service debt compared with average credit card holders who use 21 percent.

According to the Démos study, African American and Hispanic households are also more likely to carry credit card debt. Compared to 54 percent of Non-Hispanic White households, 84 percent of African-American and 79 percent of Hispanic households carry credit card balances.

White households carry higher credit card debt overall, but African Americans and Latinos use more of their available credit balance. African Americans use 84 percent of their available balance and Latinos 79 percent compared with 53.7 percent for Whites. Higher balances across the board may reflect increases in late fees and cash-advance surcharges assessed on the cards: from 1989 to 2004 the number of accounts accruing late fees of 60 days past due or more rose from 4.8 percent to 8 percent of total cardholders.

"Just as other disasters can foster awareness of the need to be prepared, the problems of excessive debt can serve as a wake-up call to take control of the future. The key is to learn more about managing finances and build reserves. "

American seniors are also racking up credit card debt. More than 35 percent of older adults are now managing credit card debt, and their average balances ballooned 194 percent from $1,169 in 1989 to $4,906 in 2004 (both shown in 2004 dollars). This debt appears more problematic in light of the fact that the 2004 median income of individuals 65 and older was $15,199. Nearly 40 percent of these seniors were living below the poverty line.

Fatal attraction
What factors are driving Americans to precariously high levels of credit card debt? Part of the explanation is that it's so much easier to get credit cards and use them.

The author of Going Broke: Why Americans Can't Hold On to Their Money, Connecticut College psychology professor Stuart Vyse, cites consumer behavior as part of the problem. "We have the ability to buy things at home, on the Internet, through television, through 800 numbers, and with cell phones and portable devices, it's much easier to do that. Thirty years ago if you wanted to buy something you had to go to town and you had to have the money," Vyse stated in an interview with ABC News.

Easier access to credit is another exacerbating factor. Whereas in the past banks only provided credit cards for customers with stable credit histories, the industry has now been able to broaden access through innovations in the underwriting of credit risk.

Until recently, almost anyone could get a credit card. As of 2004, three out of every four households had a credit card. Now that the credit card market is over 20 years old, lenders (not brokers as in the housing industry) have become more sophisticated about how they securitize credit card debt.

piggybank with broken credit card

In addition to easy access and an expansion of the occasions to use credit cards, many consumers are turning to credit cards to cope with the dual challenges of rising costs and diminishing buying power. Real wages in many areas have not kept pace with the combined increases in housing, transportation and health care costs.

A more fundamental problem?
In May 2008 National Public Radio featured a five-part series that examined Americans' relationships with credit cards. According to economy.com analyst Mark Zandi, the rising debt taken on by consumers masks "a fundamental problem, particularly among those half of households that have lower incomes. They have been under a lot of pressure over the years. The jobs that they had in manufacturing have been lost, and they're competing against labor all across the world and suffering as a result. They used debt to try to supplement their incomes and now they can't."

Increases in credit card debt thus seem to hinge on more than just lifestyle choices and social pressure to consume. According to a 2005 national survey of low- and moderate-income households by Démos and the Center for Responsible Lending, 20 percent of respondents indicated that this was "the first time their credit card debt was this high."

Furthermore, 70 percent reported that they used their credit cards as a safety net to pay for car repairs, basic living expenses, medical bills and house maintenance. More than 30 percent used credit cards during four of the last 12 months to cover basic living expenses. Renters seem especially vulnerable: 45 percent of renters used credit cards for living expenses as opposed to 28 percent of homeowners.

Holes in the safety net
Loss of a job or major medical expenses were cited as primary reasons families relied on credit cards to get by. The social and financial systems that once buffered American families from hardship provide less protection than they once did. The following table changes in some of these safety nets over the past 30 years.

Changes in safety nets over the past 30 years
Then Now
Unemployment benefits—maximum duration 15 months (1975) 6 months (2004)
Percentage of workers covered by pensions 40% (1980) 20% (2004)
Federal budget for job training $27 billion (1985) $4.4 billion (2004)

Percent of workers with employer-provided health insurance 72% (1979) 60% (2004)
Source: Peter G Gosselin, "The New Deal: If America is Richer, Why Are Its Families Much Less Secure?," Los Angeles Times (October 10, 2004); reprinted in "The Plastic Safety Net," published by Démos and the Center for Responsible Lending, October 2005.

The next generation may face even sharper cutbacks in their social investment and safety net as priorities shift to the senior population. Scholars Eugene Steuerle (a Senior Fellow at The Urban Institute, co-director of the Urban-Brookings Tax Policy Center) and Adam Carasso (Former Research Director, Fiscal Policy Program at the New America Foundation until April 2008, when he left to join the House Budget Committee as Chief Economist) found that between 1960 and 2005, federal spending on children declined from 20.1 percent of the domestic budget to 15.4 percent, while non-child Social Security, Medicare, and Medicaid spending soared from 22.1 percent to 45.9 percent.

Trouble in the credit card market?
Looking at the rising cost of living in relation to incomes and consumer attitudes toward credit, some analysts predict that the next financial crisis will be in the credit card market. Associated Press reporter Bob Porterfield says that October 2007 saw a 26 percent rise in the number of credit card holders making payments at least 30 days late. Porterfield co-wrote the article "Credit Card Crunch" with reporter Rachel Konrad after compiling statistics and reviewing spending patterns. He says defaults and delinquencies are surging, possibly an indication of more problems to come.

A recent Smart Money article by Aleksandra Todorova discusses troubling trends in credit card payments. The rate of delinquency at the country's 100 largest banks has risen in the last year as have charge-offs. However, the credit card outlook might not be as dire for lenders as the subprime mortgage market has been. For now delinquency rates are still lower than during the last recession of 2002 to early 2003, when they were close to 5 percent. Banks have managed credit card risk for several decades and know how to adjust their underwriting criteria and capital to weather a downturn.

Helping consumers adjust
Consumers are likely to feel the effects of burgeoning credit card defaults as many banks in response reduce credit lines, tighten access to new lines of credit, assess higher fees and rates for those who have been late in making payments, and initiate more aggressive collection efforts.

Several advocacy groups are seizing this opportunity to increase awareness about a whole range of asset-building and consumer protection initiatives. Démos, the Center for American Progress, the New America Foundation and many others have worked to create a platform of policy changes designed to increase financial literacy, savings and access to affordable banking services. They are also garnering financial support to mend the American safety net and foster responsible lending practices.

Just as other disasters can foster awareness of the need to be prepared, the problems of excessive debt can serve as a wake-up call to take control of the future. The key is to learn more about managing finances and build reserves.

This article was written by Nancy Montoya, senior regional community development manager in the Atlanta Fed's New Orleans Branch.