If you are one of the millions of Americans who carry a balance on your credit cards, you may be about to experience a credit crunch. Many credit card companies are preemptively lowering credit limits due to the growing financial crisis, often with little or no warning.
CNBC reports that credit card issuers are tightening up on lending as millions of Americans lose their jobs and find their income cut from loss of hours. Many of the changes to credit card terms require notification periods but credit limits can be changed instantly.
“We knew the purge was going to come at some point, but it looks like it may have started,” said Matt Schulz, chief credit analyst at LendingTree.
The reason for the changes is two-fold. First, banks have less money to lend in the midst of the financial crunch. Second, borrowers have less money to repay loans and are at a higher risk of becoming delinquent.
The changes have several important implications for credit card users. The most obvious is that if you tend to carry large balances on your cards, you may find that you do not have any available credit. In the case of someone trying to use credit cards to replace lost income, credit card spending could quickly screech to a halt.
Less clear to most consumers is the effect that a lower credit limit will have on your credit rating. One of the calculations that goes into a credit score is the debt-to-limit ratio. This ratio assesses total debt in proportion to the total credit limit. If your credit limit is reduced, you’ll have a higher debt-to-limit ratio with the same amount of debt that you owed before.
For example, if you had a $10,000 credit limit and owed $1,000, your debt-to-limit ratio would be 10 percent. If your credit limit was reduced to $5,000, the same amount of debt would represent a 20 percent debt ratio.
Generally, you should try to keep your debt-to-limit ratio below 30 percent. If it goes higher, your credit score may drop and creditors may increase your interest rates or deny you new loans.
Obviously, the best way to handle the situation is to not carry balances on your credit card and keep debt to a minimum. However, in the midst of a financial crisis may be too late for some to adopt a strategy of paying down debt.
Another possible course of action is to contact the bank and asking them to reverse the decision to lower your credit limit. Additionally, it might be possible to open a second credit card and transfer part of the balance. This would allow you to keep the debt ratio low.
CNBC also points out that many banks are offering assistance to borrowers who are unable to pay their bills due to the pandemic. Don’t just stop making payments, however. To qualify, you must contact your bank and ask for help. Participating banks may allow borrowers to skip payments or pay less, but be aware that interest and fees may be accruing, putting you deeper into debt.
As with any debt crisis, the first step in getting yourself out of the hole is to stop digging. If you can afford to do so, now is a fantastic time to stop financing your lifestyle with credit card debt. If you can start paying your debt down now, you’ll be in a better position if and when the financial crisis impacts your family.