The Coronavirus versus Credit Cards
By: Trist'N Joseph
Tags: Credit Cards, Data, Finance, Covid 19, Data Science

The Coronavirus versus Credit Cards

Over 15 million Americans have skipped their credit card payments, but is this a significant cause for concern?

Image from AARP

We have heard this time and time before; owning a credit card is essential because it means getting access to a line of credit, having additional methods of payment available, receiving benefits and rewards such as travel miles from other companies, and building a strong credit history which will positively affect one’s credit score. Now, credit scores speak directly to financial power. They provide data for lending institutions, and this data helps determine how likely it is that a person will repay their debts. An excellent credit score, which ranges from 720 to 850, signifies that an individual has a long history of consistently making payments on time, and these individuals are most likely to get approved for loans and other lines of credit from lending institutions. There are many factors which are used to determine credit scores, but as can be seen, payment history is a significant factor. With this said, recent data have shown that over 15 million Americans have skipped their credit card payment, and that represents a 10,000% increase when compared to this period in 2019. So, what does this mean for credit, credit scores, and credit card companies?

Image from Coastal Wealth Management

Credit cards a form of unsecured debt. This meaning that the card owner’s debt is not backed up by any form of collateral, and because the credit card issuers cannot recoup their expenses if the owner fails to pay down their balance, the companies will often charge higher interest rates than on other loans. Another major risk of owning a credit card is falling into a debt trap. This is when an individual borrows more money than they can afford to repay, and the debt then becomes complied due to exceedingly high-interest rates. Thus, why would 15 million persons decide to skip their payment? Well, this data includes persons who have declared financial hardship because of COVID-19. Declaring financial hardship allows them to temporarily defer payment, interest-free, for a predetermined period. This type of program was necessary as COVID-19 is significantly increasing credit card debt. Data show that approximately 23% of American cardholders have increased their credit balance as a direct result of coronavirus lockdown, and about 40% of Americans cannot afford to make more than the minimum payments on their balances. These numbers also show that Millennials were hit the hardest, as 1 out of every 3 of them increased credit card debt out of necessity. At the end of 2019, the average credit card debt was approximately $5,700, where the lowest income earners made up the largest percentage of overall debt. This could be because the lower-income earners had no other option but to use a credit card to cover their expenses on essentials, and they fell victim to the debt trap.

New York Fed Consumer Credit Panel/Equifax

Another concerning piece of information is that the overall consumer debt has reached an all-time high, exceeding $14 trillion. Consumer debt refers to personal debts owed as a result of purchasing goods or services that are used for individual [or household] consumption. Consumer debt consists of student loans, auto loans, mortgages, and credit card debt. This debt is often considered to be a suboptimal form of financing by economists because it often comes with high rates that make the loans increasingly difficult to pay back. At this point, being a consumer does not seem that attractive, and one might think that credit card companies are benefiting from enormous profits due to interest rate charges. Although there is some merit to that thought, credit card companies lose significant amounts of money when consumers default (or fail to pay their outstanding balance). Data before COVID-19 pandemic suggest that approximately 10% of all credit card owners default and companies are concerned about a surge in this number due to current circumstances. The closure of businesses and mandatory stay at home orders have caused lenders to understand that collecting payments at this time will be difficult; thus, the financial hardship program was set up to curb the rate of default. The primary concern is that persons will put themselves into more debt by borrowing more money, and this can be seen from the 23% increase in credit card balances.

Image from The Positive Economist

Banks are not just implementing these programs to protect consumers from themselves. The banks also need to ensure that they can remain solvent. They cannot continuously lend out money to consumers without receiving payments because they will eventually have no more money to lend out. As a result, banks have begun cutting credit card limits [without warning]. This makes sense because if people lose their jobs and continue to use their savings to maintain their lifestyles, credit cards are typically next in line. If these persons are then not able to secure a job which will aid them in repaying their credit card debt, this will result in a default and a loss to the credit card company. Thus, lenders have decided to get ahead of this problem and mitigate the risk of consumes running up charges on their credit cards. This then begs the questions, what happens when the economy reopens? Would consumers then be able to repay their credit card debts? If debts go unpaid, this will ruin credit scores, and credit card companies will be less likely to lend money to other persons in the future. A lack of credit will induce a decrease in consumer spending within the economy, which will restrict the economy’s growth and recovery.

However, not all of this is entirely bad news. Although consumer debt is over $14 trillion, the majority of this debt is from mortgage financing. This comes during a time where mortgage interest rates are at an all-time low, so it makes sense for individuals who can afford to invest now, as it will end up costing less in the long run. Secondly, the Federal Reserve’s data show that consumer credit [usage] dropped for the first time in March since August 2011. This is different from the previously mentioned 23% increase in credit balances as this usage refers to the portion available credit being used by an individual, as opposed to the number of individuals using credit. This is good because low credit usage positively affects an individual’s credit score; it suggests that they are not heavily reliant on credit. Lastly, there is no major downside to declaring financial hardship. The process is fairly easy, and it gives consumers a bit of a break when it comes to repaying credit card debt, even if they can afford to repay the debts currently. Thus, the spike in numbers is not that surprising, especially if persons are unsure about their financial future, and the numbers should be interpreted with caution.

The outcome within this industry is largely dependent on how long it takes for a COVID-19 treatment to developed, and how long it takes for the economy to stabilize thereafter. Chances are, credit card companies might become stricter on who they make credit available to, while also reducing credit limits and increasing interest rates if they determine that the risk of default is high. If used properly, credit cards can be a great tool for all the benefits listed before. But be sure not to fall into the debt trap, especially on things that are not necessary. If stuck within a debt trap, prioritize paying off debt, consider transferring balances to a 0% interest credit card, and take up extra work (if you have the ability to do so).