Consumers’ Access to Credit

During the past two years, American consumers have enjoyed vigorous economic growth.  Our second quarter GDP was 4.1%.  The beginning of November showed an annual wage growth rate of 3.1%, 7.4 million job openings, and an unemployment rate of 3.7%. 

Those economic conditions welcome recent graduates and some of the marginally attached workers into employment.  Modest mortgage rates and 2.0% inflation lured some first-time buyers into home ownership, and some millennials who thought they would never need a car have changed their minds.  The combination of consumer spending and tax-cut fueled capital spending by business makes for optimism that these good times may continue.

There are however, a few clouds on the horizon.  Trade frictions are cutting into the revenues of some sectors.  The stock market has been frighteningly volatile. The Federal Reserve’s persistent hikes in interest rates are weakening demand for new homes and increasing the cost of consumer debt, which is at a high.  At the end of June 2018, consumer mortgages and home loans stood at $15.1 trillion.  Student loans represent a $1.48 trillion long term drag on 44 million youthful debtors.  Revolving consumer credit balances (mainly from credit cards) were $977 billion.  If you are employed and face little debt, these are good times.

Debt loads impact consumers differently.  As normally the case, wealthy individuals have little difficulty obtaining credit, but perhaps they have little need for borrowing.  Steady interest rate normalization by the Federal Reserve makes little difference to the upper and middle class ($35,000 to $100,000 annual income) households.   However, for those with limited assets or with imperfect credit history, today’s economy can look challenging, as they struggle to arrange for affordable mortgages, automobile loans, and sometimes, cash to cover day-to-day expenses.  Subprime borrowers are those with a history of delinquent loans and little ability to repay new loans, and even in today’s good times, they feel an uphill tilt in the financial landscape.

Financial institutions are readying themselves for a correction in credit markets.  Many of the credit card customers for Discover and Capital One are subprime borrowers. Since the start of 2018, the two credit card issuers adjusted loan portfolio in anticipation of potential delinquencies.  Discover shut down inactive credit cards to sidestep their being used as a plug during a customer’s cash flow crisis.  Both card issuers are cutting back on offers that encourage balance transfers from other cards.  Market wide, the spending limit for cards newly issued to subprime borrowers has decreased from an average of $1,155 in 2016 to $949 in 2018 – about 20%.

The credit card issuers’ caution is well founded“6.3 million Americans are 90 days late on their auto loan payments.”  Bloomberg reported, “Delinquencies on subprime loans made by non-bank lenders are soaring toward crisis levels.”  Part of the problem is the extended duration of new car loans.  The loans now run an average of 69.3 months, up 6.8% from 5 years ago.  The extended risk makes some lenders wary.  Lenders such as credit unions are major sources of automobile financing because they regard it as part of their mission.  They charge an average of 11.78%, less than non-banks would charge subprime borrowers.

For those who can get it, a credit card loan that is faithfully repaid is the smart way to borrow for low income and subprime borrowers.  Least advantageous tactics are the very short-term loans from so-called “payday lenders.”  The payday lenders make loans of up to $2,500 and charge $15 per $100.  The loan and fee are due in full at the end of two weeks.  If not repaid, the loan can be rolled over, in effect restarting the loan and adding another $15 per $100 borrowed.  It is very expensive to the borrower. However payday loans may become a horror from the past. But wait, there’s more.

The Consumer Finance Protection Board has proposed a regulation requiring that the lender must assess the borrower’s ability to repay the entire loan within 30 days.  If the borrower is deemed unable to repay the loan, then the loan must not be made.  This regulation is scheduled to take effect in January 2019.  It will likely result in denial of credit to many subprime borrowers who are judged unable to repay the loan.  With far fewer borrowers, many of the lending offices will be shuttered.  That can leave subprime borrowers at the mercy of loan sharks.

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