Mortgage holders aren't the only borrowers getting themselves into trouble:
US consumers are defaulting on credit-card payments at a significantly higher rate than last year, raising the prospect of problems in the stricken US subprime mortgage market spreading to other types of consumer debt.Credit-card companies were forced to write off 4.58 per cent of payments as uncollectable in the first half of 2007, almost 30 per cent higher year-on-year. Late payments also rose, and the quarterly payment rate – a measure of cardholders’ willingness and ability to repay their debt – fell for the first time in more than four years.
Analysts at Moody’s, the rating agency, said the trend could be related to the slowdown in the US property market and a fall in the number of borrowers rolling their mortgage debt into new and cheaper home loans.
There are multiple avenues for the spread. The credit contraction, to begin with; just as it's making it hard for strapped borrowers to refinance, it's also cutting down on those zero balance transfer deals that some people use to get themselves out of trouble, or at least stave off the bailiffs.
But of course, there's also the fact that for the last ten years, many homeowners have resolved crushing credit card debt by borrowing money on the value of their homes. That's suddenly gotten much harder to do, which may be forcing people into default.
And, obviously, people who are having trouble meeting their mortgage payments may decide that Visa and Mastercard need to get in line behind the bank with the power to kick them out of their house.
No one knows which of those things is dominant, however; or even how deeply the two phenomena are related. As the article says:
But it is not clear that the borrowers defaulting on their credit cards are the same people defaulting on their subprime mortgages, it added. This is in part because underwriting standards in the credit-card sector have been more robust than in the mortgage industry. Also, many highly leveraged subprime borrowers, with little or no equity in their homes, may choose to default on a mortgage before risking being unable to charge everyday necessities to their credit card.
This doesn't seem like a good strategy; the conventional wisdom is hold onto the house! On the other hand, the conventional wisdom that said "Buy a house ASAP!" doesn't seem to be working out so well for subprime borrowers, so perhaps it's time to give the CW a rethink.
Megan:
"[U]nderwriting standards in the credit-card sector have been more robust than in the mortgage industry..."
???? Are we talking about the sector that sends out approximately 2.7 quintillion unsoliticted credit offers per each American man, woman and child (and sometimes pets)? Which would have been harder for the late Finnegan to obtain: a credit card or a mortgage?
Dr. Manhattan--The mortgage would have been harder to obtain, but almost solely because Finnegan would have had little use for a $500 mortgage loan at 18-22% APR. Credit cards like that do exist and in great numbers. Know anyone with bad credit getting offers for a Visa with a $100k limit? Neither do I.
Megan--The CW on holding onto the house relates to what happens in bankruptcy and was developed in a period when almost all borrowers had 20% equity in their house. Now, few of the S-P borrowers have any equity in their houses (many, many are upside down). If you have no equity, and could replace the house *as a residence* for lower monthly payments, it's irrational to attempt to keep the house. Thus, in the unusual situaiton where the S-P borrower is living in the ancestral home, perhaps he tries to keep making the payments. But in the far more common circumstance of yet another tract-home/McMansion, it's just crazy to not let the house go--you could (not in the current lending enviro, but . . .) buy the house back in three months at a substantial discount.
Credit-card companies were forced to write off 4.58 per cent of payments as uncollectable in the first half of 2007, almost 30 per cent higher year-on-year.
I wonder what the two and especially three and four year comparisons are. After all, the first half of 2006 saw a steep temporary decline in bankruptcy filings (and hence in written off credit card payment) because of the rush of people to declare bankruptcy in 3Q and 4Q 2005 before the new bankruptcy law kicked in. For the latter reason, the two year rate is pretty messed up as a comparison as well.
I think it a scary but real fact that many people were using their home loans as a way to manage their daily credit lines.
What I find amazing is how so many people say that no one saw this coming.
Salaries on average for the most part stopped growing at an above inflation pace upon the internet bust. Meanwhile, Americans have, on average, been decreasing their savings and increasing their debt loads for years now. With the cost of borrowing kept so low over the past several+ years, itself a factor in the escalation in real estate prices, people have understandably (not advocating just saying its obvious) tapped into their house for liquidity instead of downsized their consumption.
It continues to amaze me how many smart people are supposed to work for the government and how very few of the actual policymakers (or those that have their ears) seems to be able to be proactive instead or reactive on any relevant topics. These low costs housing loans and the amount of refinancing among them. Of course its complicated and ripe for abuse. One should have been able to hear this train coming from about 4 miles away.
What's not well understood is that the prime / subprime distinction is driven by credit scores; and credit scores give you points for borrowing money and paying it back.
So, someone who has been living beyond their means for the past few years, running up their credit cards, then refinancing them into their mortgage, will have an excellent credit score. The credit score then determines how much the lender will charge, and how much they (or bondholders) will expect in losses.
These borrowers stuck themselves with unrefinanceable mortgages, maxed-out credit cards and unrealistic expectations for their monthly budgets. And the lenders/bondholders stuck themselves with overleveraged, irresponsible borrowers and unrealistic expectations about their losses.
Sauce for the goose...
Also, many highly leveraged subprime borrowers, with little or no equity in their homes, may choose to default on a mortgage before risking being unable to charge everyday necessities to their credit card.
Wow. That's one one of the scariest, craziest things I've read in a long, long time. Only in America.
Here's a charming thought: banks are also exposed to asset backed securities supported by credit card obligations. They make up a reasonably large part of the commercial paper market, which is a large part of the obligations that make up money market funds, supposedly one of the most secure kinds of mutual funds.
Mortgage debt is generally non-recourse, as opposed to credit card debt, correct? So by shifting the debt from the credit card to the house, one conceivably is escaping some of the consequences of default.
The Austrians saw this coming 10 years ago, but no one listens to them because they're crazy, what with their preference for sound money and whatnot.
I work in the residential construction biz and spent the boom explaining over and over again why I would not buy a house. Why on earth would I buy a house at peak prices, when I knew the bubble would pop and I could buy the same house at significantly less? Foolish me, living within my means, not accumulating credit card debt, and waiting 'til the bust to buy a house.
I think most people are idiots when it comes to real estate and credit in general. Conventional wisdom is not the correct term. It's actually retardation on a massive scale.
"Conventional wisdom is not the correct term. It's actually retardation on a massive scale."
Christina succinctly lables the malady at hand.
I'm sure the CW 'thinks' that we need more Debt to cure our Debt problems, and more Government to salve the rest of our ills.
"Mortgage debt is generally non-recourse, as opposed to credit card debt, correct? So by shifting the debt from the credit card to the house, one conceivably is escaping some of the consequences of default."
Posted by Tom T.
If by "non-recourse" you mean that you won't owe the bank if the house auctions off for less than the debt + expenses, that's not true in Michigan, and I don't think it's true in many of the other states. If you've got negative equity, you'll still owe money after the house is repossessed and sold off. Perhaps a full bankruptcy proceeding can get you out from under the deficiency.
But I can see why someone who has lots of untapped credit on his credit cards and who expects or hopes that his financial difficulties are temporary might stiff the mortgage bank first. The credit cards will be blocked as soon as they realize you stopped paying them, but it takes several months for a bank to go through the courts and foreclose; maybe you'll find a job that will let you start making payments again before you're kicked out, or your rich uncle will die, Theresa Heinz will kick out Kerry and marry you, or a gold meteorite will land in your back yard... (Those last three aren't at all reasonable expectations - unless you've actually got a rich uncle on life support - but most people are wishful-thinking idiots.)
"most people are wishful-thinking idiots"
I think not. Most of us have fixed rate mortgages and positive equity in our homes. Some of us even held on and refinanced the PLUS loans for the kids education at under 4%. Many of us pay off our credit card balances every month and max out the 401K contribution. We don't think "Flip this House" is a financial planning tool.
Maybe you need to associate with a betterclass of people.