Researchers uncover ‘pecking order of defaults’ as belts are tightened
20 September 2022: Consumers are staring down a wall of ﬁnancial uncertainty as interest rates continue to rise and the war in Europe shows no end in sight.
In a ground-breaking research project, the University of Sydney and credit bureau illion have conﬁrmed which ﬁnancial products are more valuable to consumers when they start to feel the pinch – and which ones they are likely to default on ﬁrst.
Researchers have established a ‘pecking order of defaults’ – bill paying priorities – conﬁrmed by the type of credit, its perceived value, the depth of relationship with the ﬁnancial provider, and the ease with which payment could be avoided.
The research has been carried out on both Australian and New Zealand consumers, ﬁnding that their respective payment preferences are very similar.
Dr Andrew Grant, a senior lecturer in Finance at the University of Sydney Business School, analysed Australasian data from illion’s extensive consumer bureau, and has drawn on further research into alternative ﬁnance and lending platforms to conﬁrm the ﬁnancial products that are more valuable to consumers under stress.
“We have found that ultimately, preserving an open line of credit – some level of liquidity – is very important when it comes to ﬁnancial stress,” he said.
“It is probably not something people have actually thought about until it directly affects them. For instance, one credit card can be maxed to the limit while the other may still have $10k on it.
“Time and again we saw that one card would be sacriﬁced, whereas another would continue to be serviced. Therefore, factors such as whether the card still had credit available were likely to inﬂuence consumer choices,” he said.
Michael Landgraf, manager of Bureau Analytics at illion, said the research conﬁrmed that consumers make choices that immediately beneﬁt them.
“Making credit repayments on products that appear to hold the highest utilitarian value is seen as most important. Consequences, such as continued access to credit and a loss of livelihood drive these choices.”
Dr Grant looked closely at when the most valued products were sacriﬁced in order to compile a list of default priorities. “We wanted to ﬁnd out what would make a person default on their home payments,” he said.
“What we have uncovered is that it’s really only when all other options are exhausted – after that person has already defaulted on other products, and has no choice.
“This is information that is really important to ﬁnancial providers, especially with rising interest rates.
“Likewise, consumers also need to be aware that the consequences of defaulting on both a personal loan and a credit card (19%) is difﬁcult to evade – even from two different lenders.
“Products with some level of utility, such as lived-in houses, cars, and mobile phones, rather than credit that has already been spent, appear to be valued by consumers. It would be particularly difﬁcult to ‘get back on your feet’ without access to essential services,” Dr Grant said.
Mr Landgraf noted that where a person’s livelihood is at stake through a loss of a house or car, the likelihood of prioritising repayments on other credit products is very low.
“It is really only a total ﬁnancial collapse that appears to lower the priority of a car loan or home loan repayment.
“Similarly, when a person defaults on their overdraft, this is quickly followed by a default on other credit facilities. It’s therefore a strong indicator of ﬁnancial ruin.
“The mobile phone also seems to be very important to the consumer, as the repayment of phone instalments is generally prioritised over credit obligations, suggesting the smartphone is now a bedrock of people’s livelihood,” he said.
The depth of the relationship with the provider – how many products the consumer has with that bank or lender – is also important when it comes to making decisions about defaulting.
The researchers have compiled a list of the top ten bills most at risk. Taking a sample of borrowers who had ever missed a payment on a major credit product, while holding at least two different products, the researchers made comparisons in the likelihood of defaulting on one or either product.
Dr Grant said that, for example, 47,557 people in the sample in Australia defaulted on either their credit card or personal loan. Of this sample, 30,546 (64%) only defaulted on their credit card, 8,126 (17%) only defaulted on their personal loan, and 8,885 (19%) defaulted on both products.
“Thus, consumers are nearly four times as likely to default on their credit card, compared with their personal loans,” he said.
Top ten bills most at risk
Default priority –
most at risk
|Used up credit card with a lender that’s not from usual bank – or a store credit card||I don’t want to damage the relationship with my primary bank|
|Unsecured personal loan which is already used||No available credit left, no collateral at risk|
|3||Credit card with outstanding line of credit||Can still help if I get into more trouble|
|4||Buy now, pay later||No credit check in most cases, so may prove valuable after defaulting on another product|
|5||Investment home loan||Typically, a higher interest rate, more expensive, less impact to livelihood|
|6||Utility bill – gas, electricity, water||Staying warm is a priority but, as an essential service, the power can’t be easily turned off|
|7||Secured personal loan/car loan||Mobility and loss of collateral is seen as a very high priority|
|8||Primary mortgage||Roof over my head|
|9||Overdraft||Last credit domino to fall, showing financial collapse if it can’t be serviced|
|10||Phone/internet bill||Most valued, need phone to live and get by in society|
Dr Grant said consumers will often think they don’t want to damage the relationship with their bank. “I might get better hardship beneﬁts from working with the bank as opposed to a third-party lender. An existing lender might have more accurate information about me – and I could beneﬁt from this down the road,” he said.
“For instance, if I have kept my promises to the bank in the past, they are more likely to work with me to ﬁnd a solution. I may also be able to access limited credit based on transaction account balances if my history is well known.”
He said newer, more innovative forms of credit like buy now, pay later beneﬁt from product design: “Buy now, pay later generally involves relatively small payment sizes, and the money comes straight out of the person’s account in four payments. This often means they jump higher in the queue of payment priorities – by default.
“If the consumer is able to use discretion, they may opt to choose to default – this is removed with buy now, pay later payments. Direct debit payment for any bill is harder to avoid. If you have to call someone to change the details in your bank account to avoid a payment, it will be harder, and will have other consequences, so you are more likely to avoid it,” he said.
Assessing the risk to lenders, illion independently found that people holding both buy now, pay later and credit card products tended to spend more on their credit card than consumers holding only a credit card.
Mr Landgraf noted that holding both buy now, pay later accounts and credit cards appeared to give the consumer the perception of greater spending power, which, in reality, risked exacerbating their ﬁnancial stress. “Given the consumer’s repayment preferences, this is a clear risk for credit card issuers,” he said.
Dr Grant concluded that lenders should pay careful attention to the products a consumer holds from other lenders.
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