Investment Glossary – Credit Card Delinquency

When we talk about the dangers of credit cards and using borrowed money to make purchases, one of the biggest problems you can run into is credit card delinquency. In short, delinquency happens when you are either unable or unwilling to make the minimum payments required by your contract with the credit card issuer. Since that issuer has lent you money with the idea being that you will repay at least a minimum amount of the outstanding balance each month, if you fail to do so, you are in breach of the contract. This can have a whole bunch of different effects, beginning with a reduction in your credit score, and eventually leading to a cancellation of your credit line if the delinquency goes on long enough.

To start, remember that all credit cards require borrowers with an outstanding balance to pay off a certain minimum amount of that balance each month. This is how you stay in good standing with a bank or other issuer. You borrowed money from them to make purchases, meaning they effectively bought those items for you. In return, you’ve promised to pay back a portion of that money every month. A delinquency means you haven’t fulfilled that promise to the minimum level required by the lender.

So what happens in a delinquency?

Well, typically most lenders won’t report a delinquency to a credit bureau if it happens just for a month. I had an instance when I had just graduated college, where because I was not particularly attentive to my finances at the time, I simply forgot to pay my credit card bill one month. I could have paid it, but I just didn’t. It did not end up getting reported, since I realized it less than a week later, and paid the balance on my card. So a one-month delinquency, for many issuers, won’t result in any significant damage to your credit score. You may get a letter, email, or call from the issuer, telling you that you missed a payment, but so long as you only miss one, there generally aren’t any major consequences.

A second missed payment, particularly if occurring in direct succession to the first missed payment, is where things start to become challenging. You will see reductions on your credit score after missing two payments in a row, though it is likely not affecting your overall creditworthiness at this point. If you do have loan applications outstanding for other money that you want to borrow (for a mortgage or car loan), then you may be in for a rough negotiation with that lender over why they should lend you money when you can’t pay your current debts. So missed payments during a loan application can cost you the ability to close on money you’re trying to borrow.

Third and fourth missed payments are real problems for your long-term creditworthiness. You may see your credit score dip by more than 100 points, you may have your ability to incur new charges on those cards halter, you could see credit limit reductions, and a host of other problems with your current lenders. Debt collection efforts typically begin after either four or five missed payments, so this is really a situation that should be avoided at all costs.

It’s important to remember that delinquency doesn’t happen because you aren’t paying off all of your balance – it happens because you aren’t paying any of your balance. While the best scenario for credit card use is paying off your balance on a monthly basis, even making the minimum payments will keep you out of delinquency. Long-term delinquencies and collections can stay on your credit report for years, making it challenging to gain access back into the credit system after you’ve made mistakes that led to a delinquency. The effects don’t last forever, but they are significant and will greatly hamper your ability to obtain new credit in the near future.