Credit Use, Misuse, and Abuse (originally written in July 2007)

Introduction

An economy based on unmanageable consumer debt is like a house built on sand. While the use of credit enables goods and services to move more freely through the market, the risk at which they are acquired can have a lasting effect on the consumer. From even a cursory look into the credit use trends in the United States it becomes clear that without good information, education, and planning, the fall from use to abuse can be quick and devastating.

This article will highlight how consumers fail to see the dangers of falling into the trap of credit misuse or abuse, particularly with credit card companies and mortgage lenders. For the purpose of simplicity, the term “lender” will be used as a general reference for credit card companies or mortgage lenders unless the specific reference is required.

Free to Lend, Free to Borrow

Prior to the 1978 Marquette Decision by the U.S. Supreme Court, credit cards were limited mostly to retail and oil companies. In their ruling, the Supreme Court effectively freed the banks to charge interest rates more suitable for generating revenue and realizing profits that were previously controlled through regulations. Because the decision allowed banks to operate under the laws from the state in which they reside, banks found locations that enabled them to offer consumers credit cards with little or no limits on interest rates and fees.

Since the 1980’s, credit cards and their use have grown exponentially. Subsequently, credit card debt has soared to seemingly uncontrollable levels. With over 1.5 billion credit cards in circulation in the U.S. and the increase in Internet purchases as well as the ease of use within retail and fast food industries, it is obvious that what was once viewed as a privileged way of using credit has become part of the very fabric that makes up a significant portion of the U.S. and global economies.

The creativity upon which lenders provide credit is not limited to credit card companies. Mortgage lenders have also created ways to entice, some would say entrap borrowers into large loans through offering initial low rates and payments. However, many find that when the introductory period is over they are not able to make the payments and ultimately the results are defaults and foreclosures.

State of the Usage

The increase in credit card use can be attributed to some very fundamental elements of human nature. In the United States, we find that the culture of the last 20 to 30 years has become one that feeds the desires to fulfill the “American Dream” of providing for our families, but often allows us to overextend our financial means. Rick Salmeron, a financial planner, was quoted in an article from The Dallas Morning News on personal finance mistakes as saying, “We make our decisions on an emotional basis, all of us.” The credit card industry knows this all too well and takes every advantage to provide what would appear to be a fair and equitable vehicle for obtaining the things consumers want. Unfortunately, for many consumers the freedom and availability of credit cards has turned what often begins as a fair and equitable situation into a nightmarish state of despair.

Also noted in the article from The Dallas Morning News, the top two mistakes people make with their personal finances are “Not having a goal and a plan for how to achieve it” and “Not being willing to change your behavior so you can get to where you want to be.” It is likely that for many people setting goals and knowing what to do to achieve them is more about training and experience. Most people will follow a pattern or a model passed down to them from their parents. Unique to credit card use is that many card holders today did not have a model to observe and subsequently follow. The credit card industry, in its current form, is still only moving through its second or third generation of consumers.

As the prevalence of credit card use increases, the amount of consumer debt increases. As a rule, the more credit that is available, the more consumers will spend. Without prejudice, credit card companies issue cards at a staggering rate. Due to the ease of access and approval, these cards would often end up in the hands of consumers with little or no education regarding revolving credit accounts. It would appear that there is a general lack of responsible financial management. This contributes to the slide from credit use to abuse.

Who’s Responsible?

Robert Scott noted in the Journal of Economic Issues that for the purpose of his analysis of credit card use and abuse, there were three groups responsible for credit card debt problems: credit card companies, consumers, and the government. While it is clear to see that the tactics used by credit card companies can be viewed as underhanded and unfair, and the government has done little to provide regulations that protect consumers from these companies, of the three groups identified, the responsibility should be placed squarely on the shoulders of the consumers. It is true that regulations can help to ensure fair commerce, but without good information and training consumers will likely encounter trouble regardless of the law.

In an article in The Washington Post, Michelle Singletary draws our attention to the Consumer Credit Counseling Service in Atlanta. During the week of July 4, 2007, this particular office encouraged people to declare their independence from credit card debt and warned that “Using credit cards for purchases can put you at risk, especially if you aren’t disciplined.” The Credit Counseling Service seems to understand and support the idea that an educated and informed consumer is one that knows good budgeting and debt management.

Does Counseling Help?

In a study published in June 2007, in the Journal of Consumer Affairs on the impact of credit counseling, several notable results were uncovered and presented. This study found that one-on-one counseling was associated with improvement in borrower credit profiles over an extended period. Credit counseling was also associated with substantial reduction in total debt and active account management. Lastly, it was stated that those who had the least ability to handle credit realized the greatest benefit from the counseling experience.

Common sense tells us that the more a person knows about a given topic the more prepared they will be when faced with choices related to that topic. Generally, counseling does help but unfortunately those who need it often do not receive it until after they encounter problems. It is clear that borrowers who have more information and education in advance are better equipped to manage their credit accounts and avoid late fees, charges, and repayment issues.

Counseling for consumers in trouble with credit debt is not the only place where efforts and responsibility should be applied. While consumers ultimately improved their overall understanding of credit use and are likely to avoid issues after receiving counseling, it becomes obvious that the other groups involved in credit use would benefit from better education. For instance, if lenders were active in providing help for those customers in a situation where repayment is difficult they would likely secure long-term business in other products and services areas. Furthermore, if lenders returned to a more stringent approval process, one that includes financial and credit use advice, they would realize a more sustainable business and revenue stream. Additionally, the government would also benefit from an improved understanding of the overall impact to the U.S. and world economies that consumer credit card debt has. This is not to suggest that regulation will solve all issues but instead provide guidelines for the purpose of minimizing the costs of bankruptcy litigation and reliance on government support.

Conclusion

Consumers and the economy as a whole will be better served when the parties involved are properly prepared to handle both sides of the lending process. Creditors will experience a more measureable and sustainable business model over a longer period of time. Today, lenders’ revenue and profit sometimes come at the expense of consumer’s inability to manage their accounts. Eventually this will catch up with these companies in one form or another. Either consumers will rebel against the companies that take advantage of them or the government will implement and enforce regulations that ultimately limit long-term business opportunities.

Proper use of credit can be a powerful and freeing way to obtain the goods and services that consumer’s desire. If the U.S. economy is to maintain a strong growth position then all parties involved, consumers, lenders, and government, must work to address the misuse. Without a firm foundation of good information and education we will see an increasingly unstable economy.

On a personal note. I do not have or use credit cards. Just over a year ago my wife and I cut up the cards and paid off the accounts. We are currently working toward being totalling debt free. I do use debit cards which allows me the same freedoms of a credit card without the risk of debt. For me and my family, we will live within our means.