Subprime consumers are falling behind on their credit card bills. From Gen Z and millennials to Gen
Borrowers with a VantageScore between 300 and 600 in these four cohorts faced an 8.9% default rate — from 30 to 59 days — in July 2023, up from 7.49% a year earlier, VantageScore data shows . Credit card borrowers with excellent credit scores (between 661 and 780) had a default rate of 0.1% in July 2023, largely in line with the previous year.
Individual data supports the VantageScore conclusions. According to the Federal Reserve Bank, credit card delinquencies at smaller banks reached a record high of 7.51% in the second quarter of 2023, compared to 6.01% at the same time last year. That’s in stark contrast to the lower default rate of 2.63% in the second quarter at the top 100 banks, compared to 1.71% a year ago.
The Fed focuses on delinquencies where borrowers are 30 days or more delinquent. It defines large banks as those with $300 million or more in assets, while smaller banks are those outside the top 100 commercial banks. According to Federal Reserve data, more than 80% of U.S. consumers had a credit card last year, while nearly half (48%) carried a balance.
“We’ve seen a huge increase in delinquencies on credit cards,” says Balbinder Singh Gill, assistant professor of finance at Stevens Institute of Technology’s School of Business in Hoboken, NJ. “In the US we only seem to solve things when there is a crisis. I am very concerned about payment arrears, especially as they impact low-wage households.”
While some commentators see this as a reflection of the creditworthiness of middle- and lower-income households, Lance Noggle, Senior Vice President, Operations and Senior Regulatory Counsel for the Independent Community Bankers of America, says these Fed figures are not detailed. enough to explain why credit card delinquencies at small banks are increasing.
With an average annual interest rate of 24% on credit cards, arrears could put these lower-income workers out of business, Gill said. “It is a very dangerous situation right now, especially for low-paid workers.” What’s even worse is that consumers can pay late fees of up to $35 per month if they miss their payments, and an APR of up to 30%, according to LendingTree.
One theory: Some smaller banks relaxed lending requirements after the 2008 recession to lure customers and increase deposits. In 2018, Congress rolled back part of the 2010 Dodd-Frank Act — which was intended to strengthen the banking system — further relaxing lending requirements for smaller banks.
This all comes at a bad time. Consumers, especially low-income Americans, are under pressure. Student loan payments will resume in October after the pandemic-era moratorium was imposed and interest rates are at a 22-year high. Although the Fed has indicated that it is unlikely to raise rates again in the near term, inflation is still above the Fed’s target rate of 2%.
“Wages are not rising at the same rate as inflation,” Gill said. “People want the same standard of living. They want to buy the same food, but that’s impossible because their wages are still low, so they use their credit cards. That’s fine for the short term, but ultimately you have to pay off the debt.”
‘Pockets of problems’ arise
More and more people are relying on plastic: Credit card debt surpassed $1 trillion in the second quarter, a milestone that signals consumers’ willingness (or need) to use credit cards. Economists say other life experiences such as medical debt, divorce and job loss can also lead to a rise in credit card debt and increase the risk of delinquencies.
The average credit card balance rose 20% to $5,947 in the second quarter of 2023 from a year ago, the highest level in a decade, according to a quarterly report from TransUnion TRU.
released earlier this month. The average credit limit per consumer reached a new all-time high for the second quarter in a row at $24,900, up 6.4% from the same period last year, the report said.
Subprime consumers, often those with lower incomes or poor credit histories, pose a greater risk to lenders. Ted Rossman, senior industry analyst at Bankrate.com, a personal finance website, sees “problems” emerging. Many too reach a tipping point where their credit card bills — and other debts — become overwhelming, he said.
“Half of credit card holders pay in full every month, avoid interest and life is great. They get rewards and buyer protection and all these benefits,” he said. “But the other half are more or less in debt with an average interest rate of more than 20%, which is the highest we’ve ever seen. That can be a major problem at household level.”
Lenders, including credit card issuers, are now tightening their credit standards, and this is being especially felt by subprime consumers, Rossman added. As a result, they are more likely to turn to alternative credit options, such as borrowing from friends and family and requesting fintech apps He added that they would receive advances on their future paychecks to cover basic living costs.
Are young people lagging behind?
If this all sounds familiar, it’s because we’ve been here before. The recent rise in credit card delinquencies creates a sense of “déjà vu,” wrote Juan M. Sánchez, an economist at the Federal Reserve Bank of St. Louis, and Olivia Wilkinson, a research associate at the St. Louis Fed, in a August report, referring to the 2008 global financial crisis.
Their analysis of credit card borrowers – across all credit scores – found that younger borrowers are more likely to fall behind on their credit card bills. They cited unemployment rates and shorter credit histories among this cohort, though they said the overall financial situation of younger borrowers may not be as dire as in the aftermath of the 2008 crisis.
They offered some explanations: When credit conditions are tight, banks may withdraw or reduce their promotional offers, such as 0% APR balance transfers, limiting borrowers’ ability to consolidate their debt at a lower interest rate. Job loss, they added, is another reliable cause of credit card delinquencies. (U.S. hiring slowed again last month.)
The end of pandemic-era benefits has also put pressure on consumers. “However, thanks to forbearance programs, limited spending during lockdowns and generous government benefits, households have maintained record default rates during the COVID-19 recession and immediately after,” the researchers said.
“While credit card delinquencies were low during the COVID-19 recession, they have been rising since late 2021,” Sánchez and Wilkinson wrote. “Current youth crime rates are close to average levels during the 2007-2009 global financial crisis.”
The good news: Debt levels are not the same as they were during the Great Recession. “Delinquencies as a fraction of total credit card debt are smaller,” she added. “However, data from the most recent quarters indicate that household financial situations could be stabilizing, especially for those under 40.”
Read: As credit card debt exceeds $1 trillion, smaller banks are seeing a worrying trend