A rise in foreclosures has caused a seemingly unlikely reaction in the credit card industry. Few people can dispute the fact that the majority of households that make up the subprime market are in worse shape financially than they were in 2006.
Credit card issuers have taken note of the collapse that is occurring in the subprime mortgage industry. According to Mintel International Group, direct mail credit card offers increased 41% for the first half of 2007, while direct mail offers to borrowers with the best credit actually declined 13%.
What they have noticed is that many debtors no longer have the reasonable ability to refinance or take out home equity loans. Underwriting guidelines have become stricter. Less credit is available for mortgage lenders to issue. Furthermore, sagging home prices are eating into homeowners’ equity.
What has happened is that instead of stripping equity out of their homes, debtors must increasingly rely on credit cards in order to get by. This is not a fix, but it can help keep them afloat for months or even years.
Credit card issuers know that if these homeowners cannot pay their credit card payments, then they are likely facing increased risk of foreclosure. Homeowners will typically max out their credit cards in an attempt to avoid losing their homes.
Once credit cards are maxed out and homeowners cannot keep up, then they begin defaulting on their mortgage. Homeowners that know they are losing their home may stop making mortgage payments altogether, which could leave more room in their budget to get caught up on credit card payments.
The timing of all of these events will be one of the biggest factors that will affect the bottom line of credit card issuers. The process of foreclosure can frequently take up to six months or more.
Mortgage lenders have some discretion as to how quickly they foreclose on a property. The federal government is in fact encouraging lenders to provide more options to help homeowners avoid foreclosure.
Credit card issuers have no such flexibility. Guidelines issued by the Comptroller of the Currency dictate that credit card issuers charge off delinquent accounts after they fall 180 days past due. At this point, accounts are generally sold to outside debt collectors.
Credit card issuers know two things that will justify such risky lending behavior. First, subprime borrowers are far more likely to incur fees by being late as well as going over the credit limit. Such fees will boost the bottom line of credit card issuers. These fees continue to increase, and they exceed 30% of total credit card revenues by some estimates.
Second, even if an account is sold to an outside collection agency, the credit card issuer is able to recoup the vast majority of the principal. Most of what they are charging off is interest and fees. They are not looking at heavy losses on these accounts. Those that do keep up with their minimum payments more than make up the difference.
If mortgage lending is suffering, then the credit card industry could easily profit from this increased marketing to subprime borrowers. The real loser is the debtor that continues to fall deeper in debt.
Still, there is relief for those that are stretched too thin. Many of the same credit card issuers that are focusing on subprime borrowers also sponsor debt management plans that can help debtors get out of debt. Debtors that get help soonest have the best chances of keeping their home and their credit.
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