A new study developed by TransUnion confirms that the "new" payment hierarchy -- where consumers pay their credit cards prior to their mortgages -- is continuing, with the trend occurring more readily than ever before.
"Conventional wisdom has always been that, when faced with a financial crisis, consumers will pay their secured obligations first, specifically their mortgages," said Sean Reardon, the author of the study and a consultant in TransUnion's analytics and decisioning services business unit. "However, a recent TransUnion analysis has found that increasingly more consumers are paying their credit cards before making mortgage payments. This analysis reaffirms the results of a previous TransUnion study that examined data between the third quarter of 2006 and the first quarter of 2008."
The percentage of consumers current on credit cards and delinquent on mortgages first surpassed the percentage of consumers current on their mortgages and delinquent on credit cards in the first quarter of 2008. This "flip" is representative of the change in the conventional wisdom around the payment hierarchy, or which debt obligations consumers would choose to pay first.
The latest study, conducted on consumers that had at least one credit card and one mortgage, examined 30-day credit card and mortgage delinquency data between the second quarter of 2008 (Q2/2008) and the third quarter of 2009 (Q3/2009). Although many industry analysts believed that a reversion to the conventional payment hierarchy would ensue once we had passed through the worst of the recession -- that has not, in fact, been the case. To the contrary, this study found that the hierarchy reversal has become even more widespread, with the percentage of consumers who are delinquent on their mortgages and current on their credit cards rising to 6.6 percent in Q3/2009 (from 4.3 percent in Q1/2008). Conversely, the percentage of consumers who are delinquent on their credit cards and current on their mortgages has decreased to 3.6 percent in Q3/2009 (from 4.1 percent in Q1/2008).
"This same trend is evident within the lowest scoring risk segment," added Reardon. "Moreover, it should be noted that the 'flip' in payment hierarchy in the lowest scoring segment was evident earlier during Q4/2007, compared to Q1/2008 for the total market."
The study found that the magnitude of delinquency in the lowest scoring segment is significantly higher than that of the total market. The delinquency rate for consumers in this segment who were delinquent on their mortgages but current on their credit cards during Q4/2007 was 19.1 percent, and rose to 29 percent in Q3/2009. In a trend similar to that of the total market, the percentage of consumers delinquent on their credit cards but current on their mortgages decreased from 18.1 percent in Q1/2008 to 14.5 percent in Q3/2009.
The payment hierarchy shifts are even more pronounced in states such as California and Florida that experienced a more severe housing bubble effect. Within California, the percentage of consumers delinquent on their mortgages but current on their credit cards increased from 3.5 percent in Q3/2007 to 10.2 percent in Q3/2009 (a 191 percent increase). In Florida, this same variable increased from 5.1 percent in Q3/2007 to 12.4 percent in Q3/2009 (a 143 percent increase). In this same timeframe, the United States experienced a 68 percent increase (from 4.0 percent in Q3/2007 to 6.6 percent in Q3/2009).
In contrast, the number of California consumers delinquent on their credit cards but current on their mortgages declined from 3.3 percent in Q3/2007 to 2.7 percent in Q3/2009. In Florida, this variable declined from 5.0 percent in Q3/2007 to 3.9 percent in Q3/2009.
"The implosion of the mortgage industry over the last 24 months, the resetting of adjustable-rate mortgages and the weak job market have all come together to redefine how consumers are managing their finances and meeting (or not meeting) their credit obligations," said Ezra Becker, director of consulting and strategy in TransUnion's financial services business unit. "The insight gained through this analysis reveals a lot about changing consumer preferences. The financial services industry must recognize and adjust to the payment hierarchy shift with judicious modifications to business models, new assessments of specific areas of risk, and by strategic revisions to acquisition and account management strategies."
The source of the underlying data used for this analysis was TransUnion's Trend Data, a proprietary historical database consisting of 27 million anonymous consumer records randomly sampled every quarter from TransUnion's national consumer credit database. Using TransUnion's standard definitions of credit card and mortgage trades, TransUnion was able to create and evaluate the custom attributes that are the basis of this study.
And from FICO:
FICO (NYSE:FICO), the leading provider of analytics and decision management technology, today announced new and troubling findings uncovered in the latest analysis offered by its subscription service for businesses, FICO® Score Trends. Reversing a long historic trend, mortgage default risk for consumers with high FICO® scores now exceeds their credit card default risk, even though most credit cards are unsecured credit and mortgages are secured by real estate. The company observed a parallel rise in mortgage delinquencies for higher-scoring U.S. consumers.
According to the analysis in FICO Score Trends, recent repayment behavior across the financial services industry has shifted significantly from historical trends. In 2008-2009, bankcard accounts were just 1.6 times more likely to become 90 days delinquent than were mortgage loans. By comparison, in 2005 bankcard accounts were more than three times more likely to become 90 days delinquent. And for borrowers scoring high on the FICO® score’s 300-850 score range, the level of repayment risk actually has become greater for real estate loans than for bankcards. In 2009, 0.3 percent of consumers with FICO scores between 760-789 defaulted on real estate loans, compared to 0.1 percent who defaulted on bankcards.
“We’re identifying lending industry situations in FICO Score Trends that to our knowledge have never been seen before,” said Dr. Mark Greene, CEO of FICO. “Economic instability is creating unknown risk in lenders’ credit portfolios as well as counter-intuitive trends in consumer behavior. While the FICO 8 score continues to prove its unprecedented power in rank-ordering consumers for risk, even low-risk consumers are changing the value they give different credit lines. As the CARD Act goes into effect next week, it likely will create additional, unhelpful pressures on the banking business.”
In FICO Score Trends, company experts found new evidence that lenders tightened their criteria for new loans in 2008-2009 and began “cherry picking” the kinds of borrowers to whom they would extend credit. Mortgage loans opened last year between April and October reflected significantly tighter standards than in prior years. In 2005, nearly 46 percent of consumers who opened a new mortgage had a FICO score less than 700. In 2008 this percentage had dropped to just 25 percent of the newly booked mortgage population. Other industry sectors experienced similar shifts. In the bankcard sector in 2005, 51 percent of consumers with a new credit card had FICO scores less than 700. That percentage dropped to just 38 percent in 2008. As lenders tightened their credit standards, it became correspondingly more difficult for consumers with delinquencies in their credit histories and lower FICO scores to qualify for additional credit.
Regional shifts in risk
FICO also examined FICO Score Trends to learn how credit risk of real estate loans and bankcards varied across U.S. regions. The company found the most dramatic shift in the Pacific region. In 2005, bankcards were 6.4 times more likely to default than were mortgage loans. That percentage dropped to only 1.3 times riskier in 2009.
Consumers in the Midwest region demonstrated the smallest relative change. Bankcards were 2.5 times more risky of default than were mortgages in 2005, but bankcards were just 1.5 times more risky of default by 2009. Borrowers in the Northeast continue to present the least amount of default risk nationally for real estate loans.
These observations were taken from FICO® Score Trends, the subscription service that provides lenders with unique access to industry FICO® score trends indexed by a range of criteria such as industry, geography and time period. Lenders regularly use FICO Score Trends to benchmark their own portfolios and trends in order to improve their risk management and forecasting.