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February 08, 2010

Do consumers in hard times pay their mortgage first or their credit cards first?

The economic downturn has forced many consumers to make difficult financial choices, one of them being the choice to make a credit card payment or a mortgage payment. Historically consumers would protect their mortgage while letting a credit card fall delinquent if forced to make the choice, but a new trend shows that consumers are choosing to pay off credit debt at an increasing rate.

A study released by Chicago-based credit bureau Trans Union found that 6.6% of consumers were delinquent on mortgages but current on credit card payments in the third quarter of 2009 but that only 3.6% of consumers were delinquent on credit card payments while remaining current on mortgage payments.

Sean Reardon, author of the study, attributed this shift to a “perfect storm” of lowering housing prices and rising unemployment. Consumers know that they may be losing equity on a mortgage but they need to stay current on credit cards since they may be living on them for day-to-day expenses.
This strategy almost always makes no sense.  Why risk your most valuable investment, your home, just to keep your credit score better.  The only time this strategy does make sense is apparently what is happening - i.e. the home is not the most valuable investment.  Thanks to the collapse of the housing market, a lot of people owe much more on their house than what they are worth.  Thus, even if they make their house payments on time, they are not gaining any equity.  But they may need their credit cards to survive (like if they are currently unemployed). 

But missing payments on anything puts your credit score at risk, which also puts your credit card limits at risk, at least until the final provisions of the new credit card law finally go into effect.  Currently, if a credit card company sees something that worries them about your credit report (like missing payments), the credit card company can lower your limit, raise your interest rate or cut you off completely.  Once the new credit card law completely goes into effect, credit card companies will lose their draconian ability to unilaterally change the terms of your agreement, so long as minimum payments are made on the credit cards, regardless of what is happening with the rest of your credit.  But until that goes into effect, be wary of this strategy if at all possible.

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