Millions of U.S. Consumers Are Escaping Subprime

Percentage of Americans with subprime scores has fallen to the lowest in more than a decade

By AnnaMaria Andriotis

The share of U.S. adults with credit scores that are considered ‘subprime’ fell to 20.7% in April, the lowest level in records going back to 2005. Photo: Elise Amendola/Associated Press

The percentage of Americans with subprime credit scores has fallen to the lowest level in more than a decade, a development that could give bank lending and the overall economy a boost.

The share of U.S. adults with credit scores that are considered “subprime” fell to 20.7% in April, the sixth consecutive year-over-year decline and the lowest level since at least 2005, when Fair Isaac Corp. FICO 1.24 % , or FICO, started tracking the data. The ranks of subprime borrowers swelled during the financial crisis, peaking at 25.5% in 2010 as mortgage payments, credit-card bills and other debts went unpaid.

The improving trend could bring relief to big banks, which tightened credit standards in the wake of the crisis. An increase in more-creditworthy borrowers could allow them to increase lending without lowering standards. Banks are desperate for revenue growth since the same superlow rates helping borrowers are also squeezing their own profits.

“It will have a positive impact on loan volume, loan growth and revenue,” said Morgan Whitacre, consumer client underwriting executive at Bank of America. BAC 0.73 % Credit-card and auto lending would be the first type of loans to benefit.

This, in turn, could bolster consumer spending and the U.S. As more people gain access to credit, consumer spending in the short term should rise because borrowers can use loans to make purchases they otherwise wouldn’t have been able to make, said Rob Martin, U.S. economist at Barclays. “It frees people from having to spend only the cash they have on hand,” he said.

“It’s good for the economy in the sense that there’s a lot less risk in the credit that’s extended,” he added.

In some ways, the improvement is natural as the housing downturn and financial crisis fade further into the past. After a set number of years, foreclosures or missed debt payments drop off consumers’ credit reports, helping increase their scores and expanding their access to financing. This is particularly true for subprime borrowers, or those whose FICO credit scores range from 300 to 599 on a scale that tops out at 850.

There are other factors at work: The economy has recovered since the financial crisis and the unemployment rate, at 4.7%, is less than half its late-2009 peak. Wage growth of around 2% isn’t as high as the Federal Reserve would like, but it is still providing consumers with more firepower.

Superlow interest rates have also played a big role by reducing the debt burden for millions of Americans. Monthly debt-service payments accounted for 10.07% of households’ disposable personal income at the end of last year, down from a peak of 13.21% at the end of 2007, according to Fed data. Low interest rates, which have lessened required monthly payments for many borrowers, have helped bring this figure down.

Many borrowers have also been paying down credit-card debt, a move that can help increase their credit scores. Martha Souder, an administrative assistant in Silver Spring, Md., says she currently has a credit score of about 712. That is up sharply from around 545 in 2012 when she had roughly $50,000 in debt spread between 25 to 30 credit cards, many of which were maxed out.

“I have suffered a really long time, and it was a crushing burden,” she said. Her goal is to buy a house in coming years.

Meanwhile, as credit scores are rising, defaults are near record lows. Some 0.81% of consumer loan dollars—including mortgages, auto loans and general-purpose credit cards—were in default as of May, the lowest level in records going back to 2004, according to the S&P/Experian Consumer Credit Default Composite Index. This is down from 0.88% a year ago and a peak of 5.51% in May 2009. Much of that improvement is due to plummeting mortgage defaults in recent years.

“People are putting those delinquencies further and further in the rearview mirror,” said Ethan Dornhelm, senior director of scores and analytics at FICO.

Borrowers also are managing their debt more responsibly, with fewer incidences of defaults and collections. Some 11.8% of borrowers were 90 days or more past due on at least one debt obligation during the 12 months through April, down from 13.3% during the 12 months through October 2013, according to FICO.

Already, consumers are starting to borrow more again. Auto-loan balances surpassed $1 trillion for the first time ever this year, according to credit-reporting firm Experian. Credit-card debt is on pace to hit $1 trillion this year. Student-loan debt continues to swell.

That does raise some cause for concern. J.P. Morgan Chase JPM 0.44 % & Co. chief James Dimon earlier this month called the auto-lending market “a little stretched.” As well, Synchrony Financial, SYF -0.97 % the largest U.S. retail-store card issuer by purchase volume and balances, recently increased its forecast for credit losses for the next 12 months. Separately, May marked the fifth consecutive month of higher defaults for general-purpose credit cards.

Still, consumer-loan default levels remain at historically low levels. And household balance sheets have gone through years of postcrisis repair. U.S. household debt was equal to 102% of disposable income at the end of the first quarter, Fed data show, down markedly from a peak of about 130% in late 2007.

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