Consumer credit is the ability to buy goods and services now and pay for them later. It may seem like a simple concept, but it has a profound impact on our economy and society. In fact, consumer credit has a history that spans centuries and continents, and it reflects the changing needs and preferences of consumers and lenders over time.
The Origins of Consumer Credit
Consumer credit is not a new phenomenon. It can be traced back to the colonial period, when merchants and retailers offered informal store credits to their customers, usually in the form of book accounts or promissory notes. These credits were based on personal trust and reputation, and they allowed customers to buy goods that they could not afford with cash.
However, consumer credit became more widespread and standardized in the 20th century, with the development of various forms of lending, such as:
- Installment sales: This is when a seller allows a buyer to pay for a good in fixed monthly payments, usually with interest. This type of credit became popular in the early 1900s, as it enabled consumers to buy durable goods such as automobiles, appliances, and furniture, which were mass-produced and marketed by the emerging industries.
- Personal loans: This is when a lender gives a borrower a lump sum of money, usually with interest, that the borrower can use for any purpose. This type of credit became popular in the mid-1900s, as it provided consumers with more flexibility and convenience than installment sales, and it also allowed them to consolidate their debts or finance their emergencies.
- Credit cards: This is when a card issuer gives a cardholder a revolving line of credit, which the cardholder can use to make purchases at various merchants, usually with interest and fees. This type of credit became popular in the late 1900s, as it offered consumers more convenience and security than cash or checks, and it also gave them access to rewards programs and cash back.
- Home mortgages: This is when a lender gives a borrower a loan to buy a house, which the borrower pays back in monthly installments, usually with interest and fees. This type of credit became popular in the mid-1900s, as it enabled consumers to achieve the American dream of homeownership, and it also stimulated the housing market and the economy.
- Student loans: This is when a lender gives a borrower a loan to pay for education expenses, such as tuition, fees, books, and living costs, which the borrower pays back after graduation, usually with interest and fees. This type of credit became popular in the late 1900s, as it helped consumers to pursue higher education and improve their career prospects, and it also supported the growth and diversity of the education sector.
The Evolution of Consumer Credit
Consumer credit has not only grown in size and scope, but also in sophistication and complexity. Some of the factors that contributed to the evolution of consumer credit in the 20th century were:
- Credit scoring systems: These are mathematical models that use various data sources, such as credit reports, income statements, and bank statements, to calculate a numerical score that represents a borrower's creditworthiness and risk. These systems became more advanced and widespread in the 80s and 90s, as they improved the efficiency and accuracy of credit decisions, and they also enabled lenders to offer more customized and competitive products and rates to different segments of borrowers.
- Securitization of consumer debt: This is the process of pooling and packaging consumer loans into securities, such as bonds or certificates, that can be sold to investors in the financial markets. This process increased the liquidity and availability of credit, as it allowed lenders to transfer their risk and free up their capital for more lending. However, it also created new challenges and risks, such as the subprime mortgage crisis of 2007-2008, which was triggered by the collapse of the market for securities backed by risky mortgages.
- Consumer credit regulation: This is the set of laws and agencies that govern the activities and practices of consumer credit providers and protect the rights and interests of consumer credit users. This regulation changed and expanded in the 80s and 90s, as the federal government enacted new legislation and established new agencies to address the issues and challenges arising from the growth and complexity of consumer credit, such as the Fair Credit Reporting Act of 1970, the Equal Credit Opportunity Act of 1974, the Truth in Lending Act of 1980, the Fair Debt Collection Practices Act of 1986, and the Consumer Financial Protection Bureau of 2010.
The Impact of Consumer Credit
Consumer credit has become an integral part of the American economy and society, as it affects the access and affordability of various goods and services for consumers, as well as their financial well-being and behavior. However, consumer credit also poses some challenges and risks, such as:
- Overindebtedness: This is when a consumer has more debt than they can afford to repay, which can lead to financial stress, default, bankruptcy, or foreclosure. According to the Federal Reserve, the total consumer debt in the US was $4.2 trillion as of December 2020, which was 3.6% higher than the previous year. The average household debt was $145,000, which was 28% of the average household income. The average credit card debt was $5,300, which was 15% of the average credit card limit.
- Predatory lending: This is when a lender exploits a borrower's vulnerability or ignorance and offers them a loan with unfair or abusive terms, such as high interest rates, hidden fees, or deceptive practices. This type of lending can trap borrowers in a cycle of debt, damage their credit, or strip them of their assets. Some examples of predatory lending are payday loans, title loans, and subprime mortgages.
- Fraud: This is when a person or an entity uses deception or misrepresentation to obtain money or property from another person or entity. This type of crime can cause financial losses, identity theft, or legal troubles for the victims. Some examples of fraud are phishing, skimming, and identity theft.
- Identity theft: This is when a person or an entity uses another person's personal information, such as name, Social Security number, or credit card number, to commit fraud or other crimes. This type of crime can damage the victim's credit, reputation, or security. According to the Federal Trade Commission, there were 1.4 million reports of identity theft in 2020, which was 113% higher than the previous year. The most common types of identity theft were credit card fraud, loan or lease fraud, and government documents or benefits fraud.
The Future of Consumer Credit
Consumer credit is a dynamic and evolving phenomenon that reflects the changing needs and preferences of consumers and lenders over time. As we enter the 21st century, consumer credit is likely to continue to grow and innovate, driven by factors such as:
- Technology: Technology is transforming the way consumers and lenders interact and transact, as it enables more convenience, speed, security, and personalization. Some examples of technology that are shaping the future of consumer credit are online platforms, mobile apps, biometric authentication, artificial intelligence, and blockchain.
- Demographics: Demographics are changing the composition and characteristics of consumers and lenders, as they influence their preferences, behaviors, and expectations. Some examples of demographic trends that are affecting the future of consumer credit are the aging population, the rising diversity, the growing millennials, and the emerging gig economy.
- Environment: Environment is affecting the demand and supply of consumer credit, as it creates new opportunities and challenges for consumers and lenders. Some examples of environmental issues that are impacting the future of consumer credit are the climate change, the natural disasters, the social movements, and the pandemics.
One of the areas where consumer credit has a significant impact is the housing market. For example, in Salt Lake City, Utah, where we live, the median home price is $504,600, which is 16.9% higher than last year. This means that most home buyers need to take out a mortgage to afford a house. However, getting a mortgage depends on several factors, such as income, credit score, down payment, interest rate, and loan term. According to Zillow, the average mortgage rate in Salt Lake City is 3.09%, which is lower than the national average of 3.13%. This means that borrowers can save money on interest payments over time. However, the lower the interest rate, the higher the credit score required. According to Experian, the average credit score in Salt Lake City is 716, which is higher than the national average of 711. This means that borrowers need to have a good credit history to qualify for a mortgage.
So, as you can see, consumer credit is a complex and dynamic phenomenon that has a long and fascinating history, a profound impact on our economy and society, and a promising future ahead. We hope you enjoyed this blog/newsletter and learned something new and interesting. If you have any questions or comments, please feel free to contact us. We would love to hear from you. Thank you for reading and have a great day!