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Consumer Credit Defaults Could Push Interest Rates Higher

Consumer credit default

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Credit Sesame investigates the effect of consumer credit defaults on interest rates.

Consumer credit defaults rose for the fifth straight month in April. That means more people are having trouble meeting their debt payments on time.

This could be a sign that consumers are having a hard time coping with the economy. Even if you personally are not falling behind on your payments, these defaults are not just someone else’s problem. Rising defaults could mean higher interest rates and tighter credit for all.

The Trend Towards Higher Defaults

As trends go, the rise in consumer defaults is one worth watching, but nowhere near anything to panic over. Yes, defaults have risen for five straight months. However, the overall consumer default level is no higher than it was a year ago. It’s still lower than it’s been for the past ten years.

So, this trend does not represent a red light for the economy. Think of it more as a flashing yellow, signaling caution.

The reason that caution light deserves attention is that defaults can have such a far reaching impact.

On the surface, default levels may seem very low. The S&P/Experian Consumer Credit Default Composite Index shows an overall default rate of just 0.50%. It’s only when you project that default rate across the massive amount of debt that consumers owe that the true significance of the numbers becomes clear.

That S&P/Experian Consumer Credit Default Composite includes mortgages, auto loans and credit card balances. Combined, there was nearly $14.9 trillion dollars of those kinds of debt outstanding as of the end of 2021.

A 0.50% default rate on $14.9 trillion in debt would leave $74.44 billion in debts unpaid.

Not only is that a significant amount, but it has risen by over $19 billion just since November, when the consumer default rate was just 0.37%:

[Insert “Annual Value of Consumer Defaults” chart from “Dollar increase in defaults” tab of Consumer Default Data Google Sheet]

If this trend towards rising defaults continues, it would have serious implications for both consumers and lenders.

Are Consumers Struggling with the New Reality?

First, consider what these rising default amounts say about consumers.

There’s no doubt that consumers are dealing with a new economic reality in 2022. This includes the following:

  • Less government support. The government provided a lot of emergency support to help people with the pandemic. These included emergency checks, expanded unemployment benefits, bigger child tax credits, a pause on student loan debt payments, and a moratorium on some foreclosures and evictions. Most of these emergency support measures have expired. That means people have to get used to making ends meet on their own again.
  • Higher prices. Just as emergency government support has gone away, expenses have risen sharply. Inflation is rising faster than at any time in the past 40 years. Consumers are feeling the pain with each trip to the grocery store and the gas pump.
  • Higher interest rates. Adding to the higher cost of living for borrowers is the recent rise in interest rates. While people with fixed-rate loans (like most mortgages) should be relatively immune, people with adjustable rate mortgages or regular credit card balances may feel the impact much sooner. Also, new borrowing will be more expensive.

So, consumers this year are working with less financial assistance from the government while facing higher prices and higher borrowing costs. Taken together, it’s reasonable to think that the five-month rise in consumer default rates is not a fluke.

Why Credit Cards Lead the Trend

A telling sign of growing consumer distress might be that bank card default rates had the biggest rise in April.

[Insert “Bank Cards Experienced the Biggest Jump in Defaults in April” chart from “Defaults by type of debt” tab of Consumer Default Data Google Sheet.]

The other components of the S&P/Experian Consumer Default Index are secured loans. With a mortgage, you risk losing your home if you don’t make your payments. With an auto loan, you risk losing your vehicle.

Debt on bank cards like credit or charge cards is different. It’s unsecured. You don’t directly forfeit any property if you don’t pay your bill.

There are other consequences, of course. You may rack up penalty charges, lose your credit card, damage your credit rating or find it difficult to get credit in the future. However, unlike with a secured loan there’s no risk of having loan collateral claimed by the lender.

So, it’s easy to understand why people might skip their credit card payments first if they’re having trouble making ends meet. That’s why credit card default rates are generally higher than mortgage and auto loan default rates. It also explains why credit card defaults can be an early indicator of the direction of consumer payment trends.

While mortgage and auto loan default rates barely budged in April, bank card defaults were up by 0.25%. That’s the biggest jump since April of 2020, when people were grappling with the onset of the pandemic.

That makes bank card default rates an important indicator to watch in the months ahead.

How Higher Defaults Can Lead to Higher Interest Rates

Even if you’re keeping up with your payments, rising default rates may still affect you. That’s because default rates are one of the things that lenders take into account when setting interest rates.

Lenders use part of the interest rates they charge everyone to pay for the money they lose on people who default. The more defaults there are, the bigger the interest rate cushion lenders have to build in.

For this reason, rising default rates are bad news for everybody. They’re a sign of distress on the part of consumers who are defaulting. They cost lenders money in principal and interest they don’t get paid.

Finally though, rising default rates may also hurt people who are paying their bills on time. They could make it more difficult to borrow in the future, and more expensive.


Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.

Richard Barrington
Financial analyst for Credit Sesame, Richard Barrington earned his Chartered Financial Analyst designation and worked for over thirty years in the financial industry. He graduated from St. John Fisher College and joined Manning & Napier Advisors. He worked his way up to become head of marketing and client service, an owner of the firm and a member of its governing executive committee. He left the investment business in 2006 to become a financial analyst and commentator with a focus on the impact of the economy on personal finances. In that role he has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications.

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