September 4, 2018
Credit Card Defaults Drop in Consecutive Months
Is there a limit to America's appetite for debt? At least one indicator suggests that the answer is no. According to the Q2 2018 Household Debt and Credit Report from the New York Federal Reserve, total household debt in America has risen for the 16th straight quarter. Our current consumer debt is just under $13.3 trillion, with $9.43 trillion of that as housing debt.
At least there's a silver lining – one economic index indicates that we are handling part of our debt load reasonably well, since credit card default rates are currently in decline.
The S&P/Experian Consumer Credit Default Composite Index is a measure of collective default rates across credit cards, auto loans, and both first and second mortgages, with each indicator also having a separate index. The Composite index shows that overall default rates have stayed relatively flat for the last three years, and the credit card default index has fallen in May, June, and July.
One Upside to Tight Credit
The S&P/Experian Composite Index has been fluctuating between 0.8 and 1 since April 2015. For perspective, the index peaked at 5.51 in May of 2009 in the depths of the housing crisis and corresponding recession. Due to years of slow economic recovery, the index dropped below 2.0 by March 2012 and slowly sank to below 1.0 over the subsequent three years. The mortgage and auto loans indexes followed a similar track over the same time period.
The credit card index peaked in April 2010 at 9.15 and dropped at a fairly steady pace to 2.49 in December of 2015. Since then, there have been several waves of increases with slightly smaller decreases. Currently, we're in one of the decreasing cycles. As of July 2018, the index fell to 3.56 from April's 3.86 value.
What does all this mean? The index changes logically reflect the tightening of credit. After a post-recession surge in defaults, credit tightened to the point where only borrowers with solid credit could get loans, resulting in fewer risky loans and fewer defaults. Credit cards are more prevalent and represent a wide variety of risk levels, making the credit card index more prone to fluctuations.
Debt Is Still Rising
Credit card defaults may be in a current decline, but credit card debt is not. The Household Debt and Credit report notes that credit card debt increased by $14 billion in the second quarter, in line with a WalletHub prediction for total outstanding credit card balances topping $1 trillion in 2018.
Credit card debt growth hits households hard because the interest rates are relatively high. The current average annual percentage rate (APR) is almost 17% – far above mortgage rates and well above the interest rates for most other varieties of debt. In addition, penalty APRs for missing a payment can reach 30%.
If you're going to carry balances frequently, it's important to keep your credit score high to get the best interest rate possible. Check your credit report regularly for any errors or signs of fraud that can drop your credit score without your knowledge. Ensure that you make all payments on time – punctual payments are the most important factor in calculating your credit score. You can check your credit score and read your credit report for free within minutes by joining MoneyTips.
The best way to avoid interest charges and excessive credit card debt is never to charge more than you can afford to pay off at the end of each month. That's not always practical – but have a plan for managing and paying down any balances to keep your debt from spiraling out of control. Balances should be temporary.
The Takeaway
Is your debt rising? That's a problem if your income isn't rising. You don't need an index to tell you if your finances are heading in the right direction.
Credit is loosening, making it easier for you to borrow more than you can afford to pay back. To avoid the temptation to overspend, set a realistic budget that gives you a surplus at the end of most months and stick to that budget. The surplus allows you to pay down outstanding balances and put away savings for an emergency fund (or a down payment for a mortgage or other large purchases).
When you have multiple debts to pay down, it's usually best to pay down the highest interest rate debt first, which is typically credit card debt. If you can afford to pay extra against the principal on mortgages and other installment loans, that's worthwhile – but build up an emergency fund first to avoid having to put unexpected expenses on your credit card.
Keep spending under control and keep balances low, and you'll stay on track for the preferred consumer default rate – zero.
If you want to reduce your interest payments and lower your debt, join MoneyTips.
Photo ©iStockphoto.com/mapodile
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