Lending Club Blog

Debt Going Up: Why Are Consumers Overusing Credit Again?

Since August of 2008, just before the bottom dropped out of the housing market and the current financial crisis got its start, credit card debt in America has dropped or stayed at the same levels.  Consumers have practiced an uncharacteristic frugality, spending less and paying off their bills in full when they do use cards. They have controlled their buying habits, because they saw the trouble that spending had gotten them into.

Until now.

In a report released by the Federal Reserve last month, credit card spending seems to be climbing back up once again.  At the end of December, it was up $2.3 billion from only a month previous, which is an annualized rate of 3.5% growth.

And that may only be the tip of the iceberg.  Banks will charge-off credit card debt that consumers cannot pay, and this isn’t collected in the Fed’s statistics. If this amount was $5 billion in December, which is a reasonable approximation, then debt could have grown by as much as 20% more than what was reported.

All of this leads us to ask, “Why?” Haven’t Americans learned anything in the last two years? What makes people think that they can add debt now, when six months ago they weren’t comfortable doing that? Has something changed?

Here are some reasons why consumers are feeling more comfortable adding debt again:

1) New Credit Card Rules
With new rules regarding credit cards, including caps on interest rates and statements that are easier to read and interpret, it’s likely that most consumers feel safer using their cards than they used to.  Even if they don’t know or understand the details of the new laws, the fact that these exist and have been reported on extensively by the media lure people into a sense of security.

However, this security might be false. Interest rates were not capped at a level most experts would consider “low.” In fact, they can still be much, much higher than the rates that come with borrowing via traditional loans. Consumers still need to take care that they don’t use credit cards to run up bills they cannot pay off, or they’ll find themselves in the same kind of trouble they were in before.

2) Economic Improvements
To most Americans, the economy seems to be doing better. Though unemployment rates are still relatively high, layoffs have, for the most part, stopped. In addition, the DOW Jones and the S&P are rising steadily, and people associate overall economic health with the health of those indexes.

While the economy is recovering slowly, that doesn’t necessarily mean that it’s a good idea to move back into the “spend today, pay tomorrow” mindset. After all, that mindset is a big part of what caused these problems in the first place. If everyone moves back to functioning that way, the economy could teeter on the edge faster than most people might think.

3) Jobs are More Stable
Though most companies aren’t hiring a lot of new positions, those who have retained their jobs are less likely to lose them than they were even a few months back. Unemployment numbers have looked better the last 3 months, plunging nearly 1 percentage point.  This means that people know how much they’re making, and feel confident in having a steady income over the foreseeable future. Thus, they’re more comfortable spending because they know that they won’t get stuck without the money to pay anything off.

There’s truth and falsehood here, though. While it’s true that having a steady income makes it easier to pay off credit card debt, running up bills so high that you struggle to make minimum payments is never a good idea. A solid income gives a little more freedom for spending, but consumers should still make sure that paying off their debt is within the capacity of their income.  Debt-to-income ratio is an important indication of a person’s credit health: the lower it is, the better.

4) Times are Tough
While many Americans are doing better, the effects of the economic crash and the credit crunch still linger in many families. With credit cards slowly becoming easier to obtain, like they were before, some of these cash-strapped folks may be covering their basic needs in the only way they know how: with credit.

It’s usually better to pay your bills than to default on them or to pay them late. However, when you pay one bill by racking up another, it’s hard to know if you’re making a good choice or not. When there’s no other option, credit cards are better than nothing. That bill will come due before you know it, though, and you’re not in a much better situation if you can’t pay it off.

5) Old Habits Die Hard
Before the markets crashed in the fall of 2008, the United States had experienced a season of market growth. In times like that, people always spend more and use credit more freely. Over time, spending money like that becomes a habit. While relative poverty can enforce frugality for a time, a society like ours, that touts material possessions and excess, will almost always go back to spending when things even out.  Perhaps, after a few months of counting every penny that comes in and goes out, Americans are feeling frugal fatigue.

Right now, Americans are tired of looking at things that they can’t have. They’re tired of feeling poor, and they feel like they’ve reined themselves in long enough. Spending less for two whole years took a lot of energy, and now that there are hints the overall situation is improving, consumers have their credit cards out and ready to go.

Let’s hope the trend is just a cyclical result of the holidays and a bit of optimism, but if Americans are spending more without the means to pay for it, we are headed to yet another set of financial troubles.

Are you using credit more or less than you used to? Tell us why in the comments.

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PS. A hat tip to Daily Finance, WalletPop, and the The LA Times for the statistics quoted in this article and some of the insights that prompted it.

Tuesday, March 8th, 2011 at 4:30 am

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