Don't Count on Credit Cards for Relief

Don't Count on Credit Cards for Relief


Free market theorists believe that the fallout from the subprime crisis will result in a natural correction: People will curb their spending habits and save money until they're out of the red. But instead of saving, some homeowners are turning to credit cards for relief.

The subprime lending crisis has resulted in pain in multiple directions. From homeowners to mortgage bankers to realtors, everyone has felt the sting. However, now that the first line of foreclosures has washed over the mortgage industry like a tsunami, a larger problem threatens to drown subprime borrowers. With no lenders willing to grant them a home equity loan, many have begun to rely on their credit cards for debt relief.

Home equity no debt consolidation hero

In the past, when credit card debts reached astronomical levels for subprime homeowners, they would take out a debt consolidation loan. Through the miracles of a second mortgage, they could roll all those hefty credit card balances into one loan with convenient, tax-deductible interest. Credit card debts would be wiped clean, and all would be well in the world.

This "robbing-Peter-to-pay-Paul" mentality was made possible by property values that seemed to be increasing at a never-ending pace. Or at least until the pace ended.

Back where they started

When home values started to tank all across America, subprime borrowers found themselves in serious trouble. They could no longer count on a home equity loan for their debts, as lenders had substantially reduced the number of second mortgages on their books.

Where do subprime borrowers turn when their preferred source of financing-the second mortgage-goes south? Where else but their old friend-the credit card. According to statistics compiled by the Federal Reserve, credit card debt increased significantly toward the end of 2007. With fewer mortgages to be found, homeowners are doing what they can to make ends meet, which unfortunately involves returning to the source of all their problems.

Keeping credit card companies happy

Credit card companies, who charge high interest rates that aren't tax deductible, are more than happy to help desperate homeowners. Unfortunately, their motives are far from humanitarian. Much of the profit for any credit card company is linked to their high rates and heavy-duty fees.

This vicious cycle of debt won't be an easy one to fix. For consumers who've experienced staggering medical bills or lost their jobs, it's difficult to generate additional income to right their ships. People who went on one too many shopping sprees may be lucky enough to sell off some of those non-essential goods and return to a more frugal lifestyle.

Either way, the practice of relying on credit cards to make ends meet is going to lead to some disastrous conclusions. The subprime lending crisis was a mess, but if people also can't make their new credit card payments, expect more pain in the not-so-distant future.