The House Committee on Financial Services will be considering this week the Credit Cardholders Bill of Rights Act, potentially landmark legislation that would mandate a higher level of fairness in credit card terms. There could not be a better time for advancing this goal: as consumers are less able to access home equity loans, they are turning to credit cards to continue their consumption. With Americans’ total credit card debt at near-record numbers, Congress should ensure a level of fairness for consumers who want to use their credit cards responsibly.
Below is a column that appeared last week that details the urgency of credit card reform.
Six of One, Half Dozen of the Other
The end of the housing boom has cut off a key financial safety net for American families. During the past decade of low interest rates, families borrowed heavily against the value of their homes to finance their consumption and increase their purchasing power. But as the credit crisis unfolded, and as the value of Americans’ homes dropped, lenders tightened standards on all types of mortgage loans, making it harder for families to access their home equity.
With the spigot of home equity turned off, families have turned to credit cards. Between April 2006 and May 2008, inflation adjusted credit card debt rose at an annualized average monthly rate of 4.1 percent. Compare this to the period from March 2001 to March 2006, when inflation adjusted credit card debt rose at an annualized monthly rate of only 1.1 percent.
At the height of the mortgage boom in the first quarter of 2006, the difference between the total dollar amount of new mortgages and the amount of money that people spent on their homes—the new mortgage debt available—amounted to $137 billion (in 2007 dollars). This means that families cashed out $137 billion worth of equity in their homes in just one quarter. Since the mortgage market has tightened, home-equity cashouts have declined precipitously (see figure 1). By the last quarter of 2007, home equity withdrawals slowed to $40 billion (in 2007 dollars). And by the first quarter of 2008, real estate investments actually exceeded total new mortgages for the first time since the current business cycle began in March 2001.
Lenders have been tightening standards as the home mortgage crisis has surged. This includes the loans that families use to borrow against the equity in their homes. Families who were once able to finance their consumption by tapping into their home equity have had an increasingly harder time getting home equity loans. In fact, in an April 2008 survey, about 50 percent of senior loan officers polled said that they had tightened terms on home equity lines of credit over the past six months.
At the same time that home equity cashouts have tapered off, credit card debt has surged, suggesting that families who are no longer able to get home equity loans have instead turned to credit cards. Starting in April 2006, nearly the same time that home equity cashouts began to decline, credit card debt soared. Between March 2006 and May 2008, the last month of data available, credit card debt rose at a rate nearly four times that from March 2001 to March 2006. So with consumers still facing weak income growth, many have now turned to credit cards rather than home equity to finance their consumption.
What’s worse is that lenders are increasing the amount of credit card charge-offs—the value of loans a lender removes from its books and charges against its loss reserves once these loans are deemed delinquent—a warning that defaults have increased and may continue to do so. In the first quarter of 2008, all lenders charged off 4.7 percent of their credit card loans, a 33 percent increase from the first quarter of 2006 when lenders charged off only 3.1 percent of credit card loans in their portfolios.
These trends clearly underscore the need for mandating a higher level of fairness in credit card terms and conditions. Consumers who use credit cards often have difficulty understanding their terms and conditions, as the pages of fine print obscure—rather than clarify—what actions will cause a lender to raise their rates or charge penalty fees. With credit card balances rapidly increasing, and in an economy where the price of everyday goods is skyrocketing, Congress should ensure a level of fairness for consumers who want to use credit cards responsibly.
Tim Westrich is a Research Associate at the Center for American Progress.