Why Consumers are Choosing to Pay Credit Card Bills Before Mortgage

Based on recent headlines warning about a jump in consumers’ credit card use, you might think we have completely forgotten the painful lessons of the recession and have relapsed to our spending spree roots.  Thankfully, you’d be wrong.  In fact, according to Charlie Wise, research director at credit reporting firm TransUnion, there’s been a radical shift in our society’s credit priorities.

At the end of last year, TransUnion’s Credit Risk Index (CRI), which measures the amount of credit risk consumers have taken on, registered an uptick for the first time since peaking in 2009.

According to Wise, mortgage delinquencies were a key factor for the rise.  The number of homeowners at least 60 days late in making their mortgage payment rose slightly in the second half of last year.  In addition, he says credit card issuers have returned to reaching out to non-prime consumers, offering to open new accounts, albeit at premium interest rates.  “That’s affecting the risk profile of the overall group.”  And, of course, we were in “holiday” mode, a time when folks traditionally ramp up their credit card use.

But Wise cautions that three months don’t make a trend.  What’s most significant is that when mortgage delinquencies began to skyrocket back in 2008, credit card delinquencies moved in the opposite direction.  “That’s the reverse of the traditional payment hierarchy,” says Wise.  In the past, consumers would first default on their credit cards, then their auto loans and lastly on their mortgages.  “Now they’re paying their bank cards first and their mortgages last.”

The sharp decline in real estate prices has Americans less concerned about preserving their homes than preserving their lines of credit. This is especially true in states such as California, Florida, Arizona and Nevada, where home prices dropped the most, and may still be worth less than the outstanding mortgage.(1)  In a lot of places, people now view their home as a liability as opposed to an asset.

On the other hand, stung by writedowns of bad accounts, banks froze or cancelled cards, raised their credit standards and virtually stopped extending credit to all but prime customers.  The end result, according to Wise is that credit cards became “a scarce financial asset.”

“Consumers are doing everything they can to preserve access to this asset.”  Not only are more people making their credit card payments on time, they’re also paying down their balances.

And here’s a 180: Wise says consumers are acting more conservatively when it comes to using their credit cards. Faced with the current uncertain economy and high unemployment, most of us are making the rational decision to reduce what we owe on our credit cards so we have credit available to tap into if and when we need it.

For the time being, Wise is cautiously optimistic about credit card usage.  “I don’t think we’re headed back” to where we were four years ago when both lenders and consumers were careless.  He’s watching to see if the increase in credit card debt taken on during the fourth quarter of last year gets paid down this quarter when folks get their income tax refunds.  And he expects that when housing prices begin to recover, we’ll return to the traditional pattern of paying the mortgage first.

1. These are by no means the only states where large numbers of residential properties are under water. According to Wise, “Twenty-five percent of the mortgages in Illinois have zero equity.”

Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content. 

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