Fed study shows lending restrictions still too tight

These days, fewer consumers are taking on debts, but a new study from a Federal Reserve bank shows that it’s not borrowers’ willingness to add these balances that is keeping them from doing so.

Since 2008, the amount of debt carried across all types of credit by consumers has fallen by 7 percent, equaling $1 trillion, and while part of that was a reluctance to deal with consumer credit obligations in the wake of the economic downturn, there was another factor in play as well, according to a new study by the Federal Reserve Bank of San Francisco. Though Americans’ borrowing might have had good reason to decline significantly in the immediate wake of the recent recession, it has still been limited significantly, and the reason for that may simply be that financial institutions are still not broadening their lending standards widely enough.

The reason for the caution

During and immediately following the recession, consumer credit quality was at lows not seen in years, the report said. That, in turn, led to significant losses for many lenders across a number of categories, which itself gave way, necessarily, to generally tighter lending restrictions.

Essentially what this decline in lender interest in extending consumers credit did was to create a sort of cycle of former borrowers with financial difficulties not wanting to take on new debts, and lenders keeping restrictions tight to avoid new borrowers falling behind on their payments again, the report said. This decline in the overall credit supply nationwide, and also the lack of demand for such accounts, is effectively what led to the kinds of borrowing practices typically observed today: In many cases, despite the economic recovery seen in the last year, institutions and consumers alike are reticent to get back into the lending game.

Mortgages’ role in debt reduction

While many consumers sought to reduce their outstanding debts following the national recession, most were not able or unwilling to eliminate their mortgage obligations, which account for about 70 percent of the total outstanding $12 trillion in consumer credit, the report said. During and following the recession, consumers with mortgages who defaulted on their home loans were able to reduce the amount they owed more quickly than those who stayed current, though this was likely the result of those defaults, which then restricted their access to other credit.

As such, when it comes to declines in non-mortgage debt for consumers with healthy versus subprime credit scores, the fact of whether a borrower has defaulted on their mortgage weighs heavily on their ability to gain access to new credit, the report said. Borrowers are likely to suffer huge declines in their overall credit scores after defaulting on a mortgage, which in turn leads lenders to largely be unwilling to extend them new lines of credit.

The lingering problem

But even as the economic recovery has been under way for some time, lending has remained extremely tight, especially for those with subrime credit ratings, the report said. The problem with this is that access to credit may be what many consumers need to rebuild their credit profiles, and they simply do not have access to it.

“[B]orrowers who defaulted on mortgages tended to experience much larger reductions in nonmortgage debt than borrowers who stayed current on mortgages,” wrote John Krainer, senior economist for the San Francisco Fed, who conducted the study. “Borrowers with low credit scores experienced larger reductions in nonmortgage debt than borrowers with high credit scores. These results suggest that tighter credit conditions also are probably restricting the flow of credit to consumers.”

Kainer went on to note that considering consumers who have credit scores of less than 650 to be subprime is more or less an arbitrary distinction, the report said. The lower the cutoff for what constitutes a subprime borrower, the more likely a greater number consumers who may now have interest in taking on debt again are being restrained from doing so. This can be particularly troubling for these potential, willing, and financially capable borrowers, given how low interest rates currently are.

Consumers with low credit scores who may have defaulted in the past on any of their loans may be considered subprime, but also may be further victimized by unfair markings on their credit reports. Fortunately, if you check your credit report, you might be able to identify such a marking on your profile, and working with a credit repair service may allow you to return your credit standing to where it should be. Checking your credit report is something you may want to do as regularly as possible to ensure that your rating doesn’t get saddled with inaccuracies.

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