Bankruptcy credit card offer

I. Background

Credit cards have become a common form of payment. Average balances have increased and use of credit cards is more widespread across income groups (Yoo 1998). Figure 1 shows that outstanding credit card loans increased steeply during the mid 1990s. Based on data from Surveys of Consumer Finances, Evans and Schmalensee (1999) show that credit cards have become more common over time: Between 1970 and 1995, the fraction of households with at least one credit card rose from 16 percent to 65 percent, the average ratio of credit card charges to income increased from 4 percent to 16 percent, and the average amount owed on a credit card went up fourfold, in 1995 dollars.

Strong competition among credit card lenders in the 1990s induced them to offer credit cards to riskier households. Black and Morgan (1999) compare cardholders in 1995 with those in 1989 to show that credit card holders became more risky customers over time. The 1995 cardholders were poorer, more likely to be single and blue-collar and to rent rather than own their home, carried higher credit card balances, and had a higher debt-to-income ratio. While the mean unpaid household credit card balance increased from $1,100 to $1,700, the median family income among credit card holders dropped from $43,000 to $38,000 (all in 1995 dollars).

In another analysis of the Survey of Consumer Finances, Bird, Hagstrom, and Wild (1999) found that although credit card debt has increased among all income groups, it has increased disproportionately among the poor and near poor. From 1983 to 1995, the percent of low-income families (those with incomes below the poverty line) with at least one credit card more than doubled, and the average credit card balance held by those families nearly doubled from $780 to $1,380 (in 1995 dollars). During the same period, the fraction of households in the highest income bracket holding at least one credit card increased only 9 percent, mainly because nearly all families in the highest income bracket already held at least one card by 1983. Compared to the 1995 survey, Kennickell, Starr-McCluer, and Surette (2000) found that by 1998 the median credit card balances owed by households in the lowest income bracket (less than $10,000 a year) almost doubled, from $600 to $1,100 (in 1998 dollars).

Among the poor, the increase in credit card debt was greater than the increase in consumer debt in general. Canner, Kennickell, and Luckett (1995) show that the fraction of low-income households with any consumer debt rose from 40 percent in 1983 to 45 percent in 1992, a much smaller increase than the increase in the fraction of those with credit card debt.

These studies show that although credit card borrowing increased throughout the income distribution, it has increased disproportionately among poorer households. All these changes could simply indicate more equal access to credit by poorer households. The findings do not indicate whether these poorer households are more likely to be delinquent on their payments. In the next section we examine the relationship between credit card borrowing and the probability of delinquency and bankruptcy, controlling for various characteristics of the borrowers.

II. Credit Card Borrowing--the Demand Side

Researchers disagree on whether and to what extent credit card borrowing leads to bankruptcy. Aggregate data indicate that a higher fraction of consumers are delinquent on their credit card loans than on consumer loans in general (Figure 3) and that both credit card delinquency and charge-off rates have been closely correlated with bankruptcy rates over time (Figure 4).

We use data from the Survey of Consumer Finances (SCF) to analyze the effect of households' credit card debt on their likelihood of being behind on payments (see the Box). To properly measure the effect of credit card debt on the probability of filing for bankruptcy, consumer data would have to be collected before the filing took place. However, the SCF does not follow the same group of respondents over time; it simply asks whether or not the respondents have filed for bankruptcy in the past. Therefore we test whether consumers having certain attributes are more likely to have filed for bankruptcy.

The average surveyed person was 49 years old. Sixty percent of respondents were married, and 66 percent owned their home. Almost three-quarters (73 percent) of households had at least one credit card. The average household carried 3.5 different credit cards and owed $1,817 on them (combined) after the last payment. In other words, that is the amount that the average household pays interest on (the average interest rate paid on the credit card with the highest balance was 9.76 percent). Given that the average credit card charges were $529 in the most recent month, the average household carried more than three months of unpaid charges on its cards.

At the same time, 58 percent of households stated that all their payments were paid in full each month in the past year and, out of the remaining group, only 6 percent stated that any of their payments were late by two months or more. In addition to credit card debt, the average household owed $33,485 in mortgage loans, over $3,000 on car loans, $1,468 in educational loans, $983 in consumer loans, $87 on charge accounts at stores (not shown), and $530 in other forms of debt. The total average household debt was $47,552. (3)

The survey gives little indication that household debt will diminish in the near future. Half of households could foresee major expenses in the next five to 10 years (such as a purchase of a new home or children's education), but only 29 percent stated that they were saving for those expenditures.

The average 1997 wage and salary income was $37,589, and total income (from all sources) was $52,295 per household. Average total assets, including financial assets, real estate, and other nonfinancial assets, amounted to $333,583. Among people who had requested a loan during the previous five years, 22 percent were rejected, mainly because of their credit history and payments records. Over 40 percent of rejections were applications for credit cards.

Approximately 8.5 percent of the households had ever filed for personal bankruptcy. Table 1 reports means for households that had filed for bankruptcy any time before the survey was conducted and for those that had never filed. As the table shows, the average filer was somewhat younger, had higher balances on his or her credit cards and higher other debts, but much lower assets. Note that the average total debt was almost identical for the two groups, although the average debt to income ratio was 89 percent for the non-filers and 117 percent for the filers, and the average ratios of credit card debt to income were 3.23 percent and 4.51 percent, respectively. (The average income was substantially higher for those who had never filed for bankruptcy.) Moreover, the filers most likely discharged their unsecured debt when they filed for bankruptcy, so the difference underestimates the ex ante difference between a household that will file for bankruptcy and one that will not. Almost 15 percent of filers were delinq uent on at least one payment during the previous year, compared to only 5 percent of non-filers.

Filing for personal bankruptcy under Chapter 7 prevents future filing for several years. Therefore credit card issuers face relatively low risk by extending credit to those who filed very recently. The table at the bottom of Table 1 shows that those who filed for bankruptcy a year or two before the survey was conducted had, on average, a high unpaid credit card debt, probably because they receive many credit card offers during that initial post-bankruptcy period. The average debt is lower for those who filed between three and eight years ago, and increases again for those who filed even earlier, perhaps because a bankruptcy flag that could limit access to credit lasts no more than 10 years.

Domowitz and Sartain (1999) found that while the ratio of credit card debt to income was the largest contribution to bankruptcy at the margin, health problems leading to medical debt were the most important factor in a household's decision whether or not to declare bankruptcy. The self-rated health profile in our sample (not shown in table) is consistent with their finding: 21 percent of filers rated their health as excellent, compared to 36 percent of non-filers, and 24 percent of filers rated their health as fair or poor, compared to 19 percent of non-filers. On the other hand, our data showed no notable difference between the two groups in the fractions with health insurance.