Need Credit? No Problem. And That's The Problem
In a nation where instant gratification is touted as a virtue,
credit is available to anyone no matter what their credit
history. This is causing personal and financial problems for
many consumers who abuse the easy availability of credit and
find themselves unable to pay back their loans.
There was a time in history when extensive credit was available
only to the aristocracy, and debt carried a social stigma for
anyone else. The poor and middle class were carefully
scrutinized when they applied for loans, and debtor's prison
awaited those who did not repay their debts.
Americans are more indebted than ever in the nation's history.
The amount owed on loans for cars, homes and credit cards adds
up to nearly 100% of annual after-tax income, according to a
report in Business Week magazine. Yet, according to the Consumer
Fedaration of America, this alarming level of indebtedness has
not deterred the moneylenders: credit card companies have more
tha $3 trillion of unused credit lines up for grabs,
approximately $30,000 per American family.
According to Fair, Isaac and Co. (FICO), the average consumer
has access to $12,190 on all credit cards combined. Not everone
is a spendthrift: more than half of cardholders use less than
30% of their total credit limit. However, one in eight is using
80% or more of their credit limit, and 1 in 10 have a total debt
greater than $10,000. Cardweb estimates that 20% of American
credit cards are maxed out.
There are specialized credit cards being offered to all kinds of
borrowers, from students to small business owners. Each
demographic group is targetted with a specific sales pitch.
People with good credit ratings can easily access lines of
credit at an interest rate of 5% or less over the current prime
rate, and such applicants are also qualified for Platinum credit
cards. However, about half of cards in circulation are Gold
cards, which require just $10,000 in annual income for
qualification.
The credit industry uses credit scores to divide potential
customers into "prime" and "subprime" markets, referring to the
prime interest rate set by banks. Elite borrowers can obtain a
line of credit on a Platinum card at an interest rate around
12%. A Gold card carries an average interest rate of 15%, while
a standard credit card charges rates around 17%. Then there's
the subprime market, which first emerged in the 1990s, dealing
with consumers whose credit scores are 500 or less, little or no
credit history, those emerging from bankruptcy and anyone with
an inconsistent performance in managing credit. These people are
often low income earners and/or poor money managers, but the
credit card industry finds a way to profit from these most needy
of borrowers.
Unlike "secured" credit cards, cards offered to subprime
borrowers require no security deposit. Credit limits start out
very low -- initially in the $100 to $500 range. However, fees
can be hundreds of dollars and interest rates can easily soar to
usurous rates of 30% or more.
The industry also offers "secured" credit cards to offer
high-risk customers. Borrowers are required to pay an up-front
security deposit from $99 to $5,000 to serve as collateral in
case of default.
Many social and business commentators have denounced the
subprime lending business for exploiting the poor, comparing the
industry's problems to depression-era banking scandals. Lenders
take on poor and desparate customers at their own risk, writing
off losses in the 15% to 17% range, versus the average industry
loss rate of 6.5%, according to CardWeb. The delinquency rate
among subprime card issuers is 10%, twice as high as the
industry average. Some credit card companies, such as NextCard,
have been unable to recoup their losses and have closed up shop.
According to many pundits, the American economy has been
thriving in the past 5 years, with a steady growth in the GDP.
However, 90% of this growth has been due to the housing bubble;
real wages have declined by 4% since 2000 while health costs
have risen by 40%. Middle and lower class Americans are becoming
increasingly financially squeezed and unable to pay their debts.
A record number of 1.3 million cardholders filed for bankruptcy
in 2004. In response, the credit industry lobbied successfully
for stricter bankruptcy laws. However, according to the Consumer
Federation of America, the increasing incidence of loan defaults
did not spur the card companies to become more discriminating in
their choice of customers. In fact, they actually boosted their
promotional campaigns to a record 5 billion solicitations (
approximately 50 per American household) compared to 3.5 billion
the previous year, many of these ads targeting the sub-prime
market. Now consider the debit card: it is decorated with the
Visa or Mastercard emblem, and has all the functions of a credit
card in that can be used at a cash register and for internet and
telephone purchases. However, it takes money directly out of the
cardholder's bank account and allows no more spending once the
account is empty. A debit card has no monthly fees and no
interest charges, and no chance of getting into debt. Perhaps
this is the best consumer solution to a credit-mad economy.