I am absolutely fascinated by the role of credit cards in today’s recession, the new credit card laws, and how both will transform the role of credit in our lives. As somebody who got way over his head by using credit cards irresponsibly in my early twenties, I’m thrilled that following in my footsteps may not be so easy for future generations. I worry, however, that if the pendulum swings too far in the other direction, difficulty in obtaining credit cards may continue to stifle both the overall economy and young Americans’ ability to become homeowners, start businesses, and build our dreams.
Why Credit is Changing
The future of credit is being shaped by today’s economy. By now, most of us understand how lenders gave too many mortgages to risky customers who couldn’t afford them. Some homeowners stopped paying and banks lost money and abruptly went from lending too much to hardly lending at all. That froze businesses’ access to credit and slowed consumer spending which, in turn, created job losses.
As Americans lost jobs, even more of them stopped paying their mortgages—and their credit cards. Banks lost more money on credit card defaults and began canceling or reducing credit lines and limiting the number of credit cards issued.
Simultaneously, our government became angry with lenders for their risky lending practices and the high interest rates and fees that caused today’s economic mess. Congress then decided (although too late to stifle this year’s flow of red ink) that regulation was needed to stop credit card companies’ dubious practices. Last week, President Obama signed a law that will make it harder for credit card companies to both raise interest rates for existing customers and market credit cards to individuals under 21.
What Will Happen to Credit Cards?
We’ve already seen credit card companies lower credit limits and make it increasingly difficult to obtain new credit. For somebody without any prior credit history, getting a first credit card today can seem impossible.
But when the new credit card laws go into effect, credit card companies will find it more difficult to profit from customers who routinely carry a balance or even pay late. Once highly profitably, these higher-risk customers will now be less desirable to the credit card companies. I expect lenders will clamp down on credit lines and increase approval criteria even further, making obtaining a credit card very difficult for anybody that doesn’t have perfect credit.
The other consequence of credit card companies facing huge write-offs on bad debts and new regulation that will reduce their profits is that they are going to have to find a new way to make money. Previously, credit card companies earned little from customers who paid balances in full every single month. In fact, the industry calls these responsible card users “deadbeats” because they never pay interest.
Now that credit card companies can’t make as much from riskier borrowers, however, they will look for ways to earn revenue from pay-every-month customers. This will come in one of two ways:
- Annual fees
- The elimination of grace periods
Few credit cards today charge annual fees, but I would expect more cards to return to fees to make up for lost interest income. A worse scenario is if credit card companies eliminate grace periods. (Most good credit cards will not charge interest as long as charges are paid in full within 30 days). If grace periods go away, even customers who pay in full every month will start paying interest.
Finally, I also expect credit card companies to begin reducing or eliminating rewards programs. They simply won’t be able to afford them anymore.
What Will Happen to Credit Card Customers?
Debit cards are already become Americans’ preferred plastic, and their use is accelerating as more Americans want to pay with money they know they have. Unless credit card companies can continue to offer valuable rewards that will entice customers to use credit cards as a primary payment tool—even if the consumer must pay an annual fee—I suspect credit card usage will sharply decline over the next few years.
My guess is that the other segment of credit card customers that use cards for short-term loans (i.e., carry a balance) will also use credit cards less as credit card companies lower credit lines and raise interest rates on even the most creditworthy borrowers. I expect many of these borrowers may begin turning to personal loans, bank lines of credit, and social lending networks like LendingClub.
What’s the Bottom Line?
In my opinion, the credit card era is ending. Sure, credit cards will be around indefinitely, but sooner or later, they will no longer be the ubiquitous pieces of plastic in everybody’s wallets. More people will choose to do without them rather than pay annual fees or high interest rates, and credit card issuers will become more selective about whom they give cards to. I wouldn’t even be surprised if credit cards began to resemble charge cards which charge and annual fee and must be repaid every month—or if carriers other than American Express begin to offer such cards.
What do you think? How will the credit card game change? Will you keep using credit cards if they cut rewards and up fees?