Need A Credit Card? No Problem. And That's The Problem

Need a credit card? No problem! And that's exactly the problem. In a nation where instant gratification is touted as a virtue, credit is available to anyone no matter what their credit history. This is causing personal and financial problems for many consumers who abuse the easy availability of credit and find themselves unable to pay back their loans.

There was a time in history when extensive credit was available only to the aristocracy, and debt carried a social stigma for anyone else. The poor and middle class were carefully scrutinized when they applied for loans, and debtor's prison awaited those who did not repay their debts.

Americans are more indebted than ever in the nation's history. The amount owed on loans for cars, homes and credit cards adds up to nearly 100% of annual after-tax income, according to a report in Business Week magazine. Yet, according to the Consumer Fedaration of America, this alarming level of indebtedness has not deterred the moneylenders: credit card companies have more tha $3 trillion of unused credit lines up for grabs, approximately $30,000 per
American family.

According to Fair, Isaac and Co. (FICO), the average consumer has access to $12,190 on all credit cards combined. Not everone is a spendthrift: more than half of cardholders use less than 30% of their total credit limit. However, one in eight is using 80% or more of their credit limit, and 1 in 10 have a total debt greater than $10,000. Cardweb.com estimates that 20% of American credit cards are maxed out.

There are specialized credit cards being offered to all kinds of borrowers, from students to small business owners. Each demographic group is targetted with a specific sales pitch.

People with good credit ratings can easily access lines of credit at an interest rate of 5% or less over the current prime rate, and such applicants are also qualified for Platinum credit cards. However, about half of cards in circulation are Gold cards, which require just $10,000 in annual income for qualification.

The credit industry uses credit scores to divide potential customers into "prime" and "subprime" markets, referring to the prime interest rate set by banks. Elite borrowers can obtain a line of credit on a Platinum card at an interest rate around 12%. A Gold card carries an average interest rate of 15%, while a standard credit card charges rates around 17%.
Then there's the subprime market, which first emerged in the 1990s, dealing with consumers whose credit scores are 500 or less, little or no credit history, those emerging from bankruptcy and anyone with an inconsistent performance in managing credit. These people are often low income earners and/or poor money managers, but the credit card industry finds a way to profit from these most needy of borrowers.

Unlike "secured" credit cards, cards offered to subprime borrowers require no security deposit. Credit limits start out very low -- initially in the $100 to $500 range. However, fees can be hundreds of dollars and interest rates can easily soar to usurous rates of 30% or more.

The industry also offers "secured" credit cards to offer high-risk customers. Borrowers are required to pay an up-front security deposit from $99 to $5,000 to serve as collateral in case of default.

Many social and business commentators have denounced the subprime lending business for exploiting the poor, comparing the industry's problems to depression-era banking scandals. Lenders take on poor and desparate customers at their own risk, writing off losses in the 15% to 17% range, versus the average industry loss rate of 6.5%, according to CardWeb. The delinquency rate among subprime card issuers is 10%, twice as high as the industry average. Some credit card companies, such as NextCard, have been unable to recoup their losses and have closed up shop.

According to many pundits, the American economy has been thriving in the past 5 years, with a steady growth in the GDP. However, 90% of this growth has been due to the housing bubble; real wages have declined by 4% since 2000 while health costs have risen by 40%. Middle and lower class Americans are becoming increasingly financially squeezed and unable to pay their debts.

A record number of 1.3 million cardholders filed for bankruptcy in 2004. In response, the credit industry lobbied successfully for stricter bankruptcy laws. However, according to the Consumer Federation of America, the increasing incidence of loan defaults did not spur the card companies to become more discriminating in their choice of customers. In fact, they actually boosted their promotional campaigns to a record 5 billion solicitations ( approximately 50 per American household) compared to 3.5 billion the previous year, many of these ads targeting the sub-prime market.

Now consider the debit card: it is decorated with the Visa or Mastercard emblem, and has all the functions of a credit card in that can be used at a cash register and for internet and telephone purchases. However, it takes money directly out of the cardholder's bank account and allows no more spending once the account is empty. A debit card has no monthly fees and no interest charges, and no chance of getting into debt. Perhaps this is the best consumer solution to a credit-mad economy.