With Credit Ruined, Many Are Paying Off the Past

The human face of rising credit card defaults are low income earners slowly drowning in credit card debt and struggling to pay off the past.

Payday loan centers are maxed out, and increasingly turning people away. Business at pawnshops is booming; pawnshop and payday loans chain EZCorp saw a 37% rise in revenues just in the second quarter of this year. Layaway programs are back in vogue at retailers like Sears, and financial counseling centers are busy like never before.

The financial crisis and recession has brought a rude awakening for many Americans, who for nearly a decade have relied on easy access to credit to finance the lifestyle of their dreams. Now, with the turning fortunes of the economy, many are struggling with rising mortgages payments, credit card debt drawing interest at punitive default rates, lower opportunities for employment, and a wrecked credit score, which makes their financial future even more uncertain.

It is official: The credit crisis has turned into a credit card crisis as well. Low income earners have been particularly hard hit. According to data from the Federal Reserve’s Survey of Consumer Finances, already in 2007, before the credit crisis hit, the percentage of people in the lowest 40 percentile of income, who were more than 60 days behind on debt payments, was more than three times as high as that of people in the top 40 percentile.

Low-income earners are more likely to get overwhelmed with credit card debt for several reasons. They earn less, and as a result they tend to owe more in relation to their disposable income. Further, their income is often more cyclical and unpredictable, and many work in jobs that are more vulnerable to an economic downturn.

Moreover, in the face of economic adversity, low-income earners have fewer resources to fall back on. Whereas high and middle income earners might be able to take out a home equity loan to tide them over, many low-income earners rent their place of residence, and have few other resources to turn to if their income goes down or they lose their job.

However, perhaps one of the factors weighing in the most is that many low-income borrowers were never educated about the consequences of taking on large amounts of credit card debt, and hence were unable to evaluate the risks they were taking on.

Since the late 1990s, credit card lenders aggressively wooed low-income borrowers and students, because they turned out to be an extremely profitable group of cardholders. This segment of cardholders used credit cards not to their own advantage, but to card issuers’ advantage. They were more likely to make only minimum monthly payments and carry big balances on their credit cards, and, as a result, paid proportionally much more in credit card interest. According to the non-profit group, the Consumer Federation of America, back in the days, as much as 75% of credit card revenue came from cardholders, who did not pay in full each month.

From the early and mid-1990s, credit use grew the fastest among low-income families, and Americans in the low-income brackets almost doubled their credit card usage. By 2007, one in four of low-income families spent more than 40% of their income on debt repayment. Despite early warnings of higher-than-average defaults among low-income cardholders, credit card companies up until the advent of the credit crisis continued to aggressively solicit new cardholders from the ranks of students and low-income earners. The money was just too good.

And so, one might argue, banks and credit card issuers, now smarting from huge losses from bad loans, ultimately in large part have themselves to blame. Unfortunately, for tax payers picking up much of the tab for the great, credit free-for-all of the last decade through government bank bailout programs, that is not much consolation.

Published: October 29, 2009