CONSUMER ISSUES

Consumers have an important role in the U.S. economy. The widespread use of credit by consumers in recent decades has helped fuel the growth of the U.S. economy. The burden of debt has also driven millions of consumers into personal bankruptcy. Some consumers have enhanced their buying power in concrete ways, including the creation of consumer cooperatives. Others have re-examined their attitudes and buying preferences to support the goals of sustainable consumption.

Consumer Credit and Creditworthiness

Credit is a type of voluntary transaction or agreement between a borrower and a lender. Under a credit arrangement the borrower receives something of value, usually a sum of money, from a lender. The borrower agrees to repay this sum of money to the lender at some point in the future. In most cases, the borrower also agrees to pay the lender an agreed upon interest payment—a fee for the borrower's use of the money. There are many types of lenders in the U.S. economy such as banks, credit unions, and finance companies. The use of credit by consumers has a long history in the United States. During the 1920s the introduction of installment credit for major purchases such as an automobile instilled a “buy now pay later” mentality in many Americans. Over the past century, the use of credit in the American economy has expanded greatly.

The convenience of credit encourages consumer spending on goods and services in the U.S. economy. In 2012 there was $2.6 trillion in outstanding consumer credit in the U.S. economy.^[1] Consumer credit includes credit purchases by people but excludes money borrowed for home mortgages. In fact, mortgage credit, the largest type of consumer borrowing, dwarfs consumer credit in the U.S. economy. In 2012 banks and other lending institutions held over $13 trillion in mortgage debt.^[2] Three common ways for consumers to use credit today are to purchase items with credit cards, charge cards, and installment credit agreements.

Credit cards and charge cards are often called plastic money because these credit instruments add convenience to financial transactions. Yet economists do not consider credit and charge cards to be money mainly because these cards do not serve as a unit of accounting or as a store of value. Instead, credit and charge cards represent a type of loan made by the institution that issued the card to the cardholder. The use of a credit card or a charge card allows a consumer to buy now. The cardholder is expected to finalize the transaction each month by paying the issuing company all or a portion of the amount borrowed plus interest. Payments are usually made by check or by automatic withdrawals from the cardholder's checking account. Credit cards and charge cards share some common features, but there are some notable differences.

A credit card is payment card allows the cardholder to purchase goods at a variety of venues such as department stores, restaurants, grocery stores, and gas stations. In addition, credit cards permit the rollover of unpaid balances from one billing cycle to the next. Credit cards are issued by banks, thrift institutions, credit card companies, or other businesses. The three dominant credit cards in the United States are Visa, MasterCard, and American Express. Credit card companies charge relatively high interest on unpaid balances. In 2012 the average interest rate charged to cardholders was 12 percent. Some issuing companies also charge annual fees and fees for cash advances.^[3]

A charge card is a payment card that allows the cardholder to purchase goods at a specific business. Charge cards usually require full payment for transactions at the end of each billing cycle. Charge cards are issued by a variety of retailers such as Sears, Macy's, Abercrombie & Fitch, and the Gap. Some charge cards carry an annual fee, but there are seldom interest charges because cardholders do not usually have rollover privileges. Some businesses also provide installment credit for major purchases. Installment credit requires buyers to repay the principal plus interest in monthly installments over a period of months or years. This practice is common in businesses that produce and sell larger items such as furniture, major appliances, home entertainment systems, and automobiles.

Most adult consumers have access to credit cards, charge cards, and installment credit because they are creditworthy. The single most important determinant of a person's creditworthiness is a favorable credit score. Consumers earn a favorable credit score by using credit responsibly. The most recognized credit score for consumers in the United States is the FICO score. FICO is an abbreviation of Fair Issac and Company, the firm that developed the software that credit bureaus use to process credit information. Credit bureaus collect personal financial data and calculate individual FICO scores for consumers. Each credit bureau calls this FICO score by a different name. The highest possible FICO score is 850, and the lowest is 300. A high FICO score results in a favorable credit rating, which tells the potential lender such as a bank or a department store that this is a low-risk consumer. Typically, a consumer with a high FICO score will receive credit or other loans, and at a lower interest rate. A low FICO score, on the other hand, tells the lender that this consumer poses a higher risk; thus, the consumer is less likely to receive credit or other loans.^[4]

The three credit bureaus—Experian, Equifax, and Transunion—collect data related to consumers' past use of credit. The FICO software enables the credit bureaus to evaluate the degree of risk lenders face if they extend credit to a certain individual. Relevant financial data includes information on the person's credit history, such as the size of the person's outstanding debts, the timeliness of past debt repayments, and whether debt collection agencies were needed to collect on past debts. An individual's FICO score is severely damaged if the person files for personal bankruptcy.

• [1] Board of Governors of the Federal Reserve System, “G.19: Consumer Credit, January 2013,” Current Release, March 7, 2013
• [2] Board of Governors of the Federal Reserve System, “Mortgage Debt Outstanding, March, 2013,”
• [3] Board of Governors of the Federal Reserve System, “G.19: Consumer Credit, January 2013,” Current Release, 7 March, 2013
• [4] “Credit Basics,”