TransUnion recently released a new study looking at the types of debt consumers prioritise during times of financial stress.
As part of the study, TransUnion explored the payment priority among popular unsecured credit products – specifically credit cards, personal loans and retail store accounts.
Unsecured products are typically used to finance small purchases and day-to-day living expenses.
When looking at roughly 375,000 consumers with this basket of popular unsecured credit products, conventional wisdom proved wrong.
“The assumption historically has been that consumers would base their payment hierarchy on the concept of future utility, prioritising credit cards over other forms of popular unsecured credit as a credit card would still be available for further use across other purchases, potentially with multiple merchants,” said TransUnion.
“Retail store cards would be next – again because future utility exists (although only with a single merchant).
“Finally, personal loans would be last because the funds have already been received and spent, and the loan would be perceived to have no future utility.”
However, the TransUnion study revealed that the most common unsecured credit hierarchy saw personal loans given the highest priority amongst consumers during times of financial stress. Next came credit cards, with retail cards at the bottom of the hierarchy.
TransUnion said that the reason personal loans were prioritised over other products may be due to the prevalence of debit orders for personal loans which are fixed and are often a non-negotiable condition of the loan.
“Thus, the consumer is less likely to ‘choose’ to pay their personal loan or not, but instead has the loan payment automatically debited, leaving them to make their payment choices among the remaining products,” it said.
When looking at why credit cards are paid ahead of retail store cards, TransUnion said that future utility may, in fact, influence consumer choice, as paying their credit cards allows them more flexibility to make future purchases from a wide range of merchants compared to their retail store cards.
There are other likely reasons for the priority of personal loans in the unsecured product payment hierarchy, it said.
“For example, personal loans have a fixed end date, and consumers can see a ‘light at the end of the tunnel’ in the near-term if they continue to meet their obligations, giving them relief from this one debt obligation.
“This contrasts with credit cards and retail store cards, which tend to have no set end date and could potentially continue indefinitely if consumers make only minimum payments on these obligations, and then charge up the remaining available credit in the next month.”
Homes, cars and credit
TransUnion made similar findings when looking at secured credit products – including vehicles, homes and credit cards.
Conventional wisdom may suggest the first product type to enter delinquency (i.e. the one consumers would miss a payment on first) would be a credit card, followed by a vehicle loan.
Further, it might be expected that only in the most dire of circumstances would consumers stop paying housing loans, prioritising those payments above all other debt types.
The rationale – so the conventional wisdom goes – is that missed payments on a card do not put any important collateral at risk, automobiles are critical for efficiently getting to daily activities, and of course the home is the centre of one’s family life and the most important asset a consumer can own.
However, the TransUnion study revealed that consumers generally place vehicle loan payments first, prioritising those payments ahead of home loans.
Credit cards, as expected, are the product in this set that consumers prioritise last and are most likely to miss.
“It might feel counterintuitive that, for most struggling consumers, vehicle loans are prioritised over other prominent credit products such as mortgages,” said Carmen Williams, director of Research and Consulting for TransUnion South Africa.
“However, there are a number of important factors to consider.
“It’s not always about protecting your home; it might be the size of the payment required, access to other forms of credit and even what you feel the perceived consequences might be.
“Consumers and lenders alike often have to wrestle with these problems, and our study looks to shed light on some of the difficult decisions consumers sometimes have to make.”
Commenting on the findings, Williams said that the study was not about delinquency but is rather about the choice and the consumer thought process during times of financial stress.
When people miss a payment it is often because of significant life events – loss of a job, a relationship breakdown, illness or even other unexpected bills, she said.
“They are not choosing whether they want to pay or not, but rather are making choices to maximize the benefit of the scarce funds they have available.
“The choices people have to make are often difficult, and our research gives a glimpse into some of the factors that are potentially important.”
She added that lenders need to understand the choices that consumers make across their wallets and the interaction effects between different product types in order to inform their underwriting and risk management strategies.
“Payment hierarchies are extraordinarily complex and dynamic, and can be impacted by external drivers such as unemployment rates, income levels and home prices,” she said.
“As these drivers shift, so can the hierarchy – and the recent economic headwinds could certainly alter consumer priorities regarding their financial obligations.
“Lenders should always be actively evaluating, refining—and when necessary, redeveloping—their consumer mindset models, in order to anticipate and be able to quickly react when borrower or economic conditions change.”