Historically, debtors have paid down their secured loans first to insure they have a place to stay, and a car to drive. That’s one reason why interest rates on these loans are lower. They are backed by tangible assets and the risk of default is traditionallly lower. A new TransUnion study shows that in the Great Recession that pattern has been reversed. Sean Reardon, the author of the survey, found that “increasingly more consumers are paying their credit cards before making mortgage payments.”
The study was conducted on consumers with at least one credit card and one mortgage. It looked at 30-day credit card and mortgage delinquency rate between the first quarter of 2008 and the third quarter of 2009. Consumers delinquent on their mortgages but current on their credit cards rose to 6.6% in quarter three of 2009, compared to 4.3% in quarter one of 2008. Conversely, the number of consumers delinquent on their credit cards and current on their mortgages has decreased to 3.6 percent in quarter three 2009 compared to 4.1% in quarter one of 2008.
Although the study does confirm that homeowners are increasingly distressed, the logic behind the priority of debt servicing is puzzling. True, credit card rates have recently skyrocketed, now up to 30% for some consumers who have never been late, an incentive to pay these debts off first. The large percentage of homes underwater on home value versus mortgage obligation might also be contributing to the trend. If borrowers increasingly see house payments as throwing good money after bad, expect an increase in mortgage delinquencies for 2010. Another reason might be the simple fact that having a credit card is nearly essential to get motel rooms these days. That option is the the last stop before the street for many foreclosed homeowners.
According to data released last Friday by the Federal Reserve Bank, Americans borrowed less for a record 11th month in a row. These numbers again show that the priority is paying down credit card debt. The category of revolving credit, including credit cards debt fell $8.55 billion in December after dropping $13.79 billion in November. Revolving credit has now dropped for a record 15 months in a row. In contrast, financing for mobile homes and auto financing did grow.
If you’re having difficulty in paying your mortgage, you can’t restructure your house payments and ignore the rest of your debt. A key provision of the Obama Affordability Plan is to cut a borrower’s mortgage payments to 31% of income while overall debt has to be less than 55% of income. Those with a higher debt to income ratio have to be entered into a US Housing and Urban Development certified consumer debt counseling program to qualify for government mortgage assistance.
It’s easy to pay off the highest interest obligations first, but be aware of the consequences of shortchanging specific bills if you are short of cash. It’s better to eat rice and beans, watching over the air TV, commuting by bus, than be homeless. A handy priority list to keep in mind is housing, health insurance, food, utilities, transportation, and then unsecured debt. Draw up your own hierarchy of needs. In some situations it’s possible to get government assistance for bills. Food banks are increasingly popular. Many utilities offer low income rate tiers. Prescription drug help can be found from some pharmaceutical companies or state agencies for some specific chronic conditions. Get creative in finding support. Don’t put your house payment last, because this is one obligation that can easily get away from you.