The Perils of Plastic

Millions of Credit Card Borrowers Facing Larger Monthly Payments

Starting in January, new federal guidelines will increase minimum monthly payments for credit card debt. Most mortgage lenders will now require payments equal to 1% of the debt plus fees, interest, and charges, rather than the previous 2%. The total payment will be over 2% of the outstanding debt in many cases. While this will reduce overall interest costs and encourage less borrowing, it may hinder the ability of many consumers to obtain a mortgage.

Current Credit Card Debt Landscape

According to a Federal Reserve report, there is currently $799.1 billion in outstanding credit card debt, averaging $2,681.54 per person. For a household of four, this equates to nearly $10,750. This debt level is compounded by a negative savings rate, with the Bureau of Economic Analysis reporting a savings percentage of -0.2% for October and November. During these months, consumers spent $37.4 billion more than they earned.

Risks of Unsecured Credit Card Financing

Credit card financing is considered unsecured debt, a high-risk form of financing for mortgage lenders. This risk results in interest rates ranging from 18% to 28%. For example, a household with $10,000 in credit card debt at an 18% interest rate and a 2% monthly repayment would take 7.8 years to repay the loan, accruing $8,622 in interest. By increasing the monthly payment to 4%, the same debt could be repaid in 2.7 years, with interest amounting to $2,628, saving nearly $6,000.

Impact of New Repayment Standards on Mortgage Applications

Mortgage lenders evaluate applications by examining borrowers' monthly expenses, which include housing costs (PITI) and consumer expenses. Expenses are assessed as a percentage of monthly income, categorized as "front" and "back" ratios. Different mortgage programs have varying ratio requirements, with conventional loans typically at 28/36, FHA at 29/41, and VA loans effectively at 41/41. Adjustable-rate mortgages often use 33/38 ratios, with some loans having even more liberal standards.

With the new credit card payment standards, a required monthly payment increase from $200 to $280 raises monthly expenses from $2,880 to $2,960. This shifts the "back" ratio from 36% to 37%, potentially disqualifying some borrowers from certain mortgage programs.

Steps to Mitigate Credit Card Impact

To optimize mortgage eligibility and savings:

1. Reduce Credit Card Use: Pay off and eliminate unnecessary credit cards, retaining one for emergencies.

2. Seek Exceptions: Consult underwriters for possible exceptions to guidelines.

3. Save More: Implement small savings habits, such as setting aside singles or coins, eating in, and reducing discretionary spending.

4. Maintain Low Balances: Always make full, timely payments to maintain zero balances.

5. Use Debit Cards: Opt for debit cards to limit spending to available funds.

6. Get Overdraft Protection: Link savings to checking accounts or establish a line of credit for overdraft protection.

Ultimately, prioritize long-term financial goals over short-term indulgences.