Pay Attention to Changes in Hierarchy of Debt Payments

Mike Ginsberg

The Washington Post featured an article in its most recent Sunday business section titled “More Americans pay credit card debt at the expense of mortgages.” In it they described how mortgages have traditionally ranked at the top of bills paid but an increasing number of consumers under financial distress are reaching to pay their credit card bill first.

They went on to say that the trend gives us reason to believe that the hierarchy of payments has changed because of the Great Recession. We believe it has changed as well, but this change has been years in the making and is not exactly in the way that the Washington Post reported.

Since before the start of the global economic crisis, we have been evaluating this hierarchy of payments theory which suggests that consumers under financial duress will elect to pay certain debts earlier and more completely than others. We are all painfully aware that creditors of all type and their ARM service providers recover based on household wallet share. It should come as no surprise that under economic duress, when monthly household budgets are not growing in any material way and in many instances going in the reverse direction based, allocation of wallet share vary significantly.

Before 2008, many debtors followed the pattern of “mortgage-then-auto-then-credit cards” hierarchy.  The logic was that a consumer would lose their house if they did not make their mortgage payment, and they would lose their car if they did not pay their auto loan, but no one would come to their house to take away their clothes or food if they did not pay their credit card bill.  Factored into the equation before 2008 was the fact that home equity loans and lines of credit were readily available and home-owning consumers tapped into these resources to pay off credit card balances.  When this option dried up at the start of the mortgage debacle, many consumers had to unexpectedly reach into savings and retirement accounts or risk going into default.

We agree with the Post article that the severity of the Great Recession bumped mortgage payments into second place — or lower — in the hierarchy, but we think this phenomenon began 18 months ago and that car payments may have moved into pole position instead of credit card payments.  As the old saying goes, “you can sleep in your car but you can’t drive your house.”

Credit cards may be a very close second to auto payments, but where they actually rank is of secondary importance for credit and collection professionals. What’s most important for those in the business of collections, whether for their own account or on behalf of others, is to pay careful attention to shifts in consumer payment patterns in any of the asset classes that underlie it and adjust collection processes accordingly.

How have you seen payment tendencies change as a result of the economic crisis and early stages of recovery?  Comment below or drop me a line and let me know.  I look forward to hearing from you.

Mike Ginsberg is President and CEO of ARM advisory firm Kaulkin Ginsberg, and can be reached by email. The firm is celebrating its 20-year anniversary in the ARM market.