Seven years in the credit-counseling business didn't prepare Ann Estes for the alarming trend she began noticing last fall: As her clients' mortgage bills became unaffordable, a growing number of them began paying their credit card bills before — and sometimes instead of — their mortgages."We've never seen anything like this," says Estes, who counsels clients by phone from her office in Richmond, Va. "Their homes are at risk, and they know it. But people say, 'I don't want to let my credit cards go because that's my cash flow.' "
Across the nation, credit counselors are reporting the same trend. Credit bureau analyses of consumer payment data show that financially squeezed borrowers have begun paying their credit card and car bills before their mortgages. That's a striking reversal from the norm, one that reflects rising desperation. It suggests that some people essentially have given up trying to stay current with their mortgages and instead are focused on using credit cards to squeak by.
If the trend persists, many economists say, it could accelerate mortgage losses and further drag down the economy.
Rising living costs, along with cheap and plentiful credit, have led consumers to rely more on plastic to pay for necessities they can't live without — and luxuries they don't want to do without. But as the economy weakens, consumers are starting to spend less on discretionary items, such as furniture and electronics, and more on such necessities as groceries and gas, according to government data. Such items increasingly are showing up on credit card bills.
"Everything's going up — dairy, gas, home taxes," says Christie Carlson, 34, a single mother of five children, ages 5 to 14, in Tomah, Wis., who enrolled in a debt-management program after racking up $20,000 in card debt. "I'm trying to pay more for everything in cash, but it's just impossible. It's not feasible right now to stop spending on the credit card."
During the past year, credit card debt has ballooned most rapidly in parts of the nation where the economy is particularly weak, including California, Florida, Arizona and Nevada, says Mark Zandi, chief economist for Moody's Economy.com.
"That suggests that people are turning to their cards in times of financial need," Zandi says. "They're losing jobs and overtime hours and other income and trying to supplement their lower incomes with more spending on credit cards."
Magnifying the problem has been the shrinking availability of a major alternative to credit cards: home equity loans. As home values have sunk, homeowners have found it tougher to qualify for such loans. So they've turned elsewhere, especially to credit cards, to cover daily expenses.
Even as mortgage growth slowed from April 2006 through December 2007, card debt accelerated, according to an analysis by the Center for American Progress, a liberal think tank in Washington, D.C.
"As people get squeezed, they still have the credit demand," says Christian Weller, a senior fellow at the center. "For a few years, mortgages and home equity lines replaced credit card debt. Now, we're swinging back to the credit cards."
Like 'broke college students'
Allen Lisowe and his wife, Jennifer, both 33, say they're living like "broke college students," relying on their credit cards to buy the "stuff we need every day," such as groceries and gas.
The Lisowes, of New Holstein, Wis., racked up about $20,000 in credit card debt in recent years, most of it from daily expenses such as gas and food. Two years ago, the couple used a home equity loan to pay credit card and auto loan bills. They say they'd consider borrowing from their home equity again, but there's little equity left to tap.
The growing reliance on plastic may explain why revolving debt — most of which is on credit cards — rose at a seasonally adjusted annual rate of 7.8%, to a record $943.5 billion, in 2007 compared with a 6.1% adjusted rate the year before, according to the Federal Reserve.
Eventually, a worsening economy could limit the rise in card debt. If the current slowdown turns into a full-fledged recession, many analysts say, lenders could clamp down further on credit. And consumers would cut back so much on discretionary purchases that, despite their increasing use of credit cards for daily necessities, the rise in overall card debt would likely slow.
There's some sign this may be occurring already: After two months of rapid increases, the growth of revolving debt slowed in December, preliminary data from the Federal Reserve indicate. Credit card figures, though, normally are volatile from month to month. It'll be three to six months before it's clear whether consumers are indeed cutting back on plastic.
The danger is that "The economy has relied on the consumer to keep it afloat for the last seven years, and there's no more gas in the tank of the consumer," says Howard Dvorkin of Consolidated Credit Counseling Services in Fort Lauderdale. "They've got nothing to give."
James Chessen, chief economist at the American Bankers Association, a trade group, predicts that "credit card debt is going to slow, but not as much" as in previous economic downturns.
During the housing boom, too many people took out mortgages they couldn't afford. Many now owe more on their houses than they're worth. Some are defaulting on their mortgages — figuring they'll lose their homes anyway — even as they keep paying credit card and auto bills, credit counselors say.
"A lot of people are exhibiting a kind of fatalistic behavior to their mortgages," says Douglas Hammond, outreach programs director at Alliance Credit Counseling. "They can't make their mortgage payment, so why (try to) make it at all? 'Let's keep my car, make my payment on my credit card, so I have some way of feeding my family.' "
When consumers are "pushed to the wall" and forced to choose between paying the mortgage or credit card bill, Chessen says, those who are likely to lose their homes may choose their credit cards, because "They still need to heat their homes, put food on their tables and fill their cars with gas."
Allowing your house to be foreclosed on is "not a smart strategy," Hammond says, "because foreclosure does horrible things to your credit score, and you'll pay high interest rates" on future loans.
Because it takes months to foreclose on a home, some consumers likely are hoping to stave off foreclosure if their finances improve, says Linda Haran, senior director of Experian Decision Analytics.
A study by Experian found that consumers with weak credit scores — but not necessarily those with strong ones — are paying their credit card bills before their mortgage payments.
The study didn't examine car loans. But an Equifax analysis shows that 38% of delinquent mortgage borrowers had kept all their credit card bills current, and 62% had kept all their auto loans current in the two-year period ending in July 2007. In the past, most people would pay late on their credit cards and auto loans before doing so on their mortgages.
This reversal in payment priorities helps explain why the rise in credit card and auto loan defaults — which occur when lenders give up trying to recover a debt — hasn't matched the pace of mortgage defaults. Credit card defaults, while rising fast, are still in line with historic averages.
As the economy has worsened, card issuers have become more selective about offering credit to new customers, and in a growing number of cases, are shrinking card holders' credit limits. Yet they're still sending more solicitations to existing credit card customers. In 2007, issuers increased their solicitations to existing customers by 15.6%, advertising rewards and other perks to promote spending, according to Mintel, a firm that tracks such mailings.
Subprime customers — among the most profitable for banks because of the high rates and fees on their cards — saw a 41% jump in direct-mail credit card offers in the first half of 2007, the latest period for which figures were available, compared with the same period the year before, Mintel found.
It's a matter of time, some analysts say, before financially squeezed consumers max out their credit cards and start defaulting in larger numbers.
"My guess is that you'll see increasing numbers of people walking away from credit card debt the same way that they're walking away from the mortgages," says Ken McEldowney, an executive director at Consumer Action, a consumer advocacy group.
When Phyllis Coleman's mortgage payment jumped 26% last year, she began withdrawing cash from her credit cards to pay the mortgage. That worked for a few months, until Coleman, 50, of Fairfield, Calif., maxed out on the cards' credit limit. She defaulted on her mortgage and now faces foreclosure on her home.
Eventually, she also had to stop paying her credit cards, which she'd been relying on to cover daily expenses. "It became too much," Coleman says, "when gas started going up. I just got deeper and deeper" in debt.
Using credit cards for gas
Consumers with the least financial resources are pressured the most by a deteriorating economy and rising living costs. For this group, credit cards are simply a way to delay the financial pain.
In recent years, banks have ramped up card rewards, enticing more people to charge their purchases. As gas costs rise to levels many people can't afford — the national average for regular gas this week was $3.16 a gallon, up 32% from the same time last year — the number of consumers buying gas with credit cards instead of cash is accelerating, says Sonja Hubbard, CEO of E-Z Mart Stores, which has 307 locations in five states.
"People have less cash in their pocket, and if you have a $10 bill, that doesn't get you a lot of gas anymore," says Hubbard, who notes that most of her customers now charge gas to credit cards.
The move toward using credit cards for daily needs is occurring among blue-collar and white-collar professionals, credit counselors say.
"I put three doctors on debt-management plans and thought, 'Wow, it's getting tough,' " says Anissa Lipscomb, a credit counselor in Gaston, N.C. The doctors had sought counseling, Lipscomb says, because of surging insurance rates, high credit card debt and patients who had defaulted on medical bills.
For years, rising health care costs have cut into families' discretionary income. But if the economy worsens, employers are likely to pass along higher health care costs to workers. That, in turn, could force more people of all income levels to boost their use of credit cards.
"Your typical American household is very vulnerable, and they've been vulnerable for a long time," says Tamara Draut of Demos, a think tank in New York. "Now that energy costs are going up, health care (costs) are going up, people are turning to credit cards."
Annie Edwards, a credit counselor in Rapid City, S.D., says a growing number of clients are charging health care expenses. Financial firms are encouraging them to do so with the rollout of cards and lines of credit designed specifically for health care, she notes.
In October, Republic Bank (RBCAA) and Humana (HUM) introduced the HumanaAdvance health care credit card, which can be used at hospitals and doctors' and dentists' offices.
The card, says Steve Trager, CEO of Republic Bank, assures users that they "will have a means to pay for unexpected health care expenses." Citigroup (C), Capital One (COF) and General Electric's (GE) CareCredit division also offer loans for medical costs.
Diane Drew, a credit counselor in Menasha, Wis., says people "want to make sure they can get the health care they need for them and their families," even if it means going into debt.
Maria Fernandez, a real estate agent in Rodeo, Calif., says the weak housing market has cut deeply into her commissions and made it harder to pay her own mortgage. Worse, the payment on her adjustable-rate mortgage jumped 17% in October. Fernandez, 40, asked her lender to modify the loan to reduce her monthly payment. She was rejected. So she's resigned to losing her house in foreclosure this year.
Meanwhile, she says she's committed to paying her credit card debts — which she's consolidated with a debt-management agency — while she has the money. "It's really stressful. I can only afford to pay my credit cards."