Rising interest rates will not substantially affect the household’s ability to repay their credit cards, but inflation will.
Impact of Rising Interest
Interest rates are on the rise, making borrowing more costly, as the price of serving the current $1 trillion in credit card debt will likely rise another 200 basis points. In addition, the Federal Reserve Bank of Chicago anticipates another 0.5% increase in May. As a result, the average interest rate on credit cards, which the Federal Reserve measured in February, will rise from 16.17% to almost 19.0% by year-end.
Some quick math is in order. Use the $1,000,000,000,000 in consumer revolving credit card debt versus the average interest rate, and you find that interest paid on credit cards will have a negligible impact on the household budget. Using the $1 trillion at the current rate of 16.17%, consumers will pay $161.7 billion in interest. At the anticipated rate of 19%, the number will rise to $190 billion. The numbers are undoubtedly significant, but when you drill it down based on the number of U.S. households, which the Census pegs at 122,354,219, the increase is only $231.30 annually, moving from $1,321.57 to $1,552.87 respectively. Break that down to get a monthly view, and the rising interest rate on credit cards will cost households an average of $19.27.
But interest rates are not the whammy for consumer budgets; there, the risk is inflation.
Impact of Inflation
As an anchor point, consider the Society for Human Resource Management (SHRM) projections for 2022.
In March, the average weekly wage was up 5.6 percent from a year earlier, the U.S. Bureau of Labor Statistics (BLS) said on April 1. But consumer prices rose 7.9 percent year-over-year in February—the most significant 12-month increase in more than 40 years—the BLS said in March.
Those numbers vary as you consider job type, industry, and location. But using the Bureau of Labor Statistics referenced number, the drama continues.
The latest figures show that inflation continues to grow. The consumer price index (CPI) had risen 6.8 percent in November 2021 from a year earlier and was up 6.2 percent in October year-over-year.
As consumer prices rose, real (inflation-adjusted) average hourly earnings fell 2.4 percent, seasonally adjusted, from December 2020 to December 2021, the BLS also reported on January 12.
Wage increases minus inflation have been negative for nine straight months, economic advisor Ritesh Jain posted.
Where Credit Cards get hit
Let’s apply this to the household budget. The U.S. Census indicates the median household income in 2020 was $67,521, down from $69,560 in 2019. Lacking more current data, for this discussion, assume that the current metric is back to $69.560. Then, back out taxes at 25%, and that median income drops to $52,170.
The median net monthly income becomes $4,347.50 using those rates before paying a mortgage or rent. Consider Bloomberg’s “Inflation Tax,” which estimates that inflation will cost households $5,200 over the next year, or $433 per month.
For credit cards, expect revolving debt to continue to rise as consumers juggle their budget, but know they will have less to repay their debts. That’s where the operational risk comes from.
Credit card issuers must balance the short-term revenue opportunity against the long-term risk. The ensuing charge-off will quickly eliminate a short-term gain on interest revenue.
In a business where revenue per card runs at about $350, varied by operational results, one $5,000 bad debt can wipe out the income from 14.3 paying cardholders. And that is where the risk lies for credit card issuers.
With the average charge-off rate for credit cards sitting at a historic low of 1.57%, credit card issuers should expect a steady incline well into 2023, which should easily hit 3%. Now is the time to contract credit card lending, tighten up credit lines, and prepare for the upcoming recession.
Or, as they say, “batten down the hatches.”
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
