After mortgages and student loans, credit cards are the biggest source of debt for U.S. households. Credit card offers are back in people's mailboxes and, with them, credit card debt. Credit card companies extended consumers $81 billion worth of credit in the fourth quarter of 2013, a whopping 32% increase over the $61 billion they provided a year earlier, according to a recent report from credit-reporting agency Experian. The company says this increase indicates increased consumer confidence. The lesson for consumers is not to let their confidence push them into imprudence
Why Banks Are Extending More Credit
Lenders became more willing to extend credit in 2013 because delinquency rates have declined significantly, Experian reports. Consumer spending demand has increased as well. These changes indicate that the economy has improved and that consumers have learned a lesson from the recession about how to manage their debt and use credit responsibly, Experian says.
Two-thirds of new credit went to consumers with the best credit scores – those in the prime (661–780) and super-prime (781–850) segments – but banks also are more willing to lend to borrowers with lower credit scores.
It didn't take long for the effects to show up – and people with poorer credit were more likely to get into debt. While delinquency is down, overall consumer debt increased 6% in 4Q 2013 compared to 2Q 2012, but only from consumers at the three lower credit-score tiers, Experian found. While outstanding credit card debt grew by $10 billion over this period, super-prime and prime borrowers collectively reduced their debt by $19 billion.
If the trend continues, expect trouble. “Consumer spending typically rises with lax credit requirements,” says Sev Meneshian, a Certified Financial Planner and president of Public Retirement Planners in Evanston, Ill., an independent financial services company that helps public-sector employees and retirees with financial planning and investment management. “Spending on consumer items continues until the payments become unsustainable, and a credit crunch inevitably follows.”
How Much Can You Get?
While banks issued more credit than in 2012, the credit limits for new cards issued in 2013 were similar, Experian reports. On average, super-prime borrowers received a credit limit of almost $9,000, while prime borrowers gained access to $6,512. Near-prime consumers got credit limits averaging $3,635, and subprime and deep subprime borrowers received access to $1,650 and $689, respectively. (Experian’s data pertain only to credit cards issued by banks, and do not include those issued by retailers.)
The Smart Way to Use Credit
The good news is that all groups of borrowers except the deep subprime group used a smaller percentage of their available credit in 2013 than the year before. Super-prime borrowers decreased their credit utilization by 15.4%, while deep subprime borrowers increased it by 1.8%. The higher a consumer’s credit score, the smaller the percentage of their credit line they used in the fourth quarter of 2013, with super-prime, prime and near-prime borrowers using 5.7%, 14.2% and 41.5%, respectively.
The amount people owe accounts for 30% of their FICO credit score; the only thing more important is repayment history, which accounts for 35%. It’s best to keep your credit utilization low and always pay your bills on time – which could mean it's prudent to say no to new card offers unless they come with a much more favorable (permanent, not temporary) rate. New credit makes up 10% of your score, and while opening a new account and increasing your available credit might help, it could also hurt. FICO cautions, “The importance of any one factor in your credit score calculation depends on the overall information in your credit report...it’s impossible to measure the exact impact of a single factor in how your credit score is calculated without looking at your entire report.”
Protecting Your Credit Score
Even if you’re using credit in a way that’s good for your credit score, you might be using it in a way that harms your finances. You should never carry debt just to boost your score. Paying your balances in full and on time is just as good for your credit as carrying a balance. Don’t succumb to this common misconception; there’s no reason to pay interest if you don’t have to.
Only about 50% of Americans have credit card debt, and they were carrying about the same amount of credit card debt in the fourth quarter of 2013, at $15,267, as they were one year earlier, at $15,366, according to a study of Federal Reserve data by website NerdWallet. As of February 2014, the average indebted U.S. household was carrying $15,191 in credit card debt.
If these figures seem high, it’s because a small number of deeply indebted households drive up the numbers, NerdWallet says. Still, they represent a substantial decrease from the fourth quarter of 2007, before the housing bubble burst, when the average indebted American household owed $18,285 to credit card companies. What's more, consumers nationwide got better about paying their credit card bills on time in the fourth quarter of 2013 compared to the same period one year earlier. Only 6.89% of accounts were past due in the fourth quarter of 2013, compared with 7.1% a year earlier.
Profiting From the Lessons of the Recession
“I think consumers are feeling more secure in their jobs, and the ability to meet their respective obligations translates into additional purchases made with credit,” says John Heath, directing attorney of consumer advocacy law firm Lexington Law, a credit-report repair specialist. He expects that consumers will continue buying durable and other consumer goods on credit, and does not see this as imprudent. “However, I think it is important to remind consumers to budget, to keep manageable credit card utilization ratios and to make sure they are making their credit payments in a timely manner,” he says.
It's easy to get caught up when people start feeling optimistic – unemployment has declined, and consumer confidence is at a nine-month high, according to the Thomson Reuters/University of Michigan April 2014 Index of Consumer Sentiment. Other consumer sentiment indicators, including the Bloomberg Consumer Comfort Index and the Conference Board’s Consumer Confidence Index, are experiencing highs as well. Retail sales also made their largest gain in 18 months in March, according to the U.S. Commerce Department, increasing 1.1% from February.
“The recent recession has been a grim teacher for most consumers; a more conservative and wary debtor has emerged,” says David C. Jones, president of the Association of Independent Consumer Credit Counseling Agencies in Orlando. He says that while credit card usage will increase overall this year, “we expect that better financial management will keep major changes from seriously impacting most families. The key here is continued improvement in the job market. The economic landscape shows enough signs of improvement to make us cautiously optimistic.”
The Bottom Line
Banks have become more willing to extend credit since borrowers have gotten better about paying their bills on time. Average credit card debt remains high for the approximately 50% of U.S. households that are carrying a balance, but most people are at least making their minimum payments on time. Economic indicators tell us that consumers are optimistic and with good reason. With most cardholders using well below half of their available credit, most don’t seem to be getting in over our heads. Consumers should continue to let the lessons learned during the recession inform wise spending habits and a judicious use of credit.