Borrowing to Get Ahead, and Behind: The Credit Boom and Bust in Lower-Income Markets

A new Brookings Institution, Metropolitan Policy Program study finds that the recent subprime implosion is only the tip of the iceberg when it comes to Americans borrowing more than they can manage. The study, written by Matt Fellowes, relies heavily on previously unavailable data, and finds that about one out of every three lower income borrowers falls behind on bill payments in a typical year, and over one out of every four now pays more than 40 percent of their income every year on debt payments.

Lending in lower-income markets has radically transformed in recent decades, highlighted by a dramatic increase in the supply of credit. However, little is known about lending variations across different lower-income markets, nor the underlying forces affecting borrowing patterns. Using Federal Reserve data and a unique database of over 14 million anonymous credit reports supplied by TransUnion, this paper examines the nation's lower-income credit and lending markets and finds:

  • Over 55 percent of lower-income households held debt in 2004, a 10 percent increase since 1989. Total debt held by these households increased by 308 percent during this period, now adding up to over $481 billion. Most of this debt is for mortgages and home-related installment trades. Over 32 percent of lower-income borrowers struggle to pay bills on time; about 27 percent now spend more than 40 percent of their income servicing debt.

  • Usage of credit in lower-income markets varies widely across the country, from a high in Boston (where 75 percent of borrowers in lower-income markets owed money in 2005) to a low in Las Vegas (where less than 40 percent did). Credit usage in lower-income markets increases as the credit scores of borrowers improves, when divorce rates and the proportion of immigrants decreases, and when the proportion of seniors increases. Total debt increases with rising credit scores of borrowers in lower-income markets, when the proportion of the uninsured and immigrants increases, and when mortgage lending policy becomes more stringent. The highest levels of indebtedness are also found in the areas of the country with the lowest costs of living.

  • Management of credit in lower-income markets also varies widely across the country, from a low in San Jose, where less than 5 percent of borrowers in lower-income markets were behind on debt payments in 2005, to a high in Memphis, where over 18 percent were delinquent on at least one bill. Delinquency rates in lower-income markets increase as unemployment rates increase, and when the proportion of borrowers without health insurance increases. Surprisingly, the highest delinquency rates in lower-income markets are also in the least expensive areas in the country.

  • Based on an evaluation of credit scores, potential growth in the supply of credit in lower-income markets is also widely variable across the country, from a low in Memphis and Milwaukee, where the average credit score in lower-income markets was 556 in 2005, to a high in Portland and San Jose, where the average score was over 635. Improvements in the credit score profiles in lower-income markets are associated with increases in credit usage, decreases in delinquency and unemployment rates, and decreases in the proportion of non-white borrowers.

  • With the expansion of lending in lower-income markets, an entirely new generation of policy implications has emerged, transcending the traditional focus on the supply of credit. Now, policymakers must also be concerned with the ability of consumers to choose from myriad different credit products, the capacity of bad apples in the credit industry to take advantage of information asymmetries and hurt both borrowers and lenders, and the need for research to assess the effect of lending on both borrowers and the businesses underwriting those loans. Yet, policymakers need to proceed cautiously with these recommendations so as to address markets with apparent problems, while preventing disruption to markets without serious problems.