Credit Card Debt Management

Farnoosh Torabi, one of the foremost financial minds of Generation Y, has posted an interesting article on TheStreet.com about why, exactly, credit limits might be shrinking. Like Torabi, my credit limit was also recently increased, much to my surprise. I have, however, been shopping home loan offers, so this will probably change shortly. Torabi and I, with our credit limit increases, appear to be in the minority if the media reports are true. Credit limits are being slashed, but why? When it happens to you, “It’s the economy, stupid,” isn’t really an adequate answer. So what are the real, nitty-gritty reasons behind the shrinking credit limits? Torabi shares her insight, and here are some of the highlights:

What are you buying? If you are putting minimal, everyday purchases like your Starbucks coffee on your credit card (i.e., things you should be able to cover with cash), that can be a giant red flag to your creditor. Torabi also points out that frequent alcohol purchases could indicate the risk of a health problem that could have financial repercussions.

Are your bills caught up? Thanks to the infamous universal default policy, your creditors are able to keep track of — and punish or reward you for — your bill-paying habits. Late on the cable bill, utilities bill, the car payment or the credit card bill? It could cost you in terms of a lower limit or at least a higher interest rate.

Where are you living? Areas of the country with tanking real estate markets, like Florida, Detroit, and Nevada, can cause problems for local residents in more ways than one. That’s right, these area residents can see their limits lowered simply because the terrible local housing market might lead creditors to believe these customers are at a higher risk of financial distress.

Where are you working Are you a realtor? General contractor? Good luck. Are you an airlines pilot? Your credit limit could see decreasing altitude in the near future. Even if you’re successful, these are currently seen as high-risk occupations and your creditors could lower your limit as a result.

Like Big Brother in George Orwell’s famous novel, these credit card companies are keeping an eye on way more than you could have ever imagined. And for good reason — they themselves are at risk of financial distress due to bad loans. So cross your T’s, dot your I’s, and remember to whip out your debit card — not your credit card — next time you’re in the Starbucks line.

If your credit card accounts are among those being affected by credit limit cutbacks, it may be affecting your FICO score by narrowing your debt-to-credit limit ratio. Creditors typically like to see this ratio at 30% or less, but if your $20,000 credit limit just got halved on a card with a $5,000 balance, your ratio just went from 25% to 50%. It can pose a problem, depending on how high your credit card balance is, but there are some steps you can take that may rectify the issue.

Call and ask. Your credit card issuer may be willing to reinstate your previous credit limit. Chances are good your credit limit reduction was the result of some arbitrary computerized decision, and a real human being may be more sympathetic if you explain your situation. If necessary, ask to speak to a supervisor who may have more bargaining power. The biggest mistake you can make is to simply take your lumps and never ask for mercy, if you really need it.

Transfer your balance. You can open a new credit card, although this will not necessarily be the best thing for your FICO score, which takes into consideration the age of all your credit accounts. You might also shift the balance from one of your existing credit card accounts onto another of your existing credit card accounts where the credit limit is higher. For instance, your card had a $4,000 limit that got sliced to only $2,000. As a result, your $1,000 balance suddenly looks much higher in relation to the limit. If you had another credit card with, say, a $5,000 limit and zero balance, the $1,000 balance would fit much better there. It will probably result in a balance transfer fee and the interest might be higher on the second card, although you might be able to call the $5,000-limit card issuer and negotiate that interest rate. Just tell them you’re considering closing the account, but the interest rate is awfully high for your liking. You may be surprised what could result. Keep in mind that negative consequences are possible from too much balance shifting. You could see an interest rate hike or even a credit limit reduction on your other credit cards.

What will happen to the credit card industry? Is it a giant, over-inflated bubble just waiting to pop and make an even bigger mess than the housing crisis? Some say yes, definitely — you decide whether they’re doomsayers or realists.

Los Angeles CityBeat had an interesting article on the topic recently. Essentially, people are using credit cards to pay their mortgages instead of using HELOCs to pay off credit card debt. Not only that, but more people than ever before are paying their credit card bills late.

Capital One, one of the biggest card issuers, wrote off $1.9 billion in bad credit card debt in the last quarter of 2007 alone. Among other savory morsels, the article points out the following:

“By last fall, the major banks were setting aside billions for loan-loss reserves while anticipating an increase of 20 percent in non-payments over the next two to four quarters.”

Marketing is more aggressive than ever. Credit cards are a more integral part of our economy than ever before. And self-control when it comes to spending is probably at its weakest point in history. Thrifty spending and “rainy day funds” are no longer the basis of our society. Instead, society’s obsession is overspending. Take, for example, this bone-chilling portion from the CityBeat article:

“It’s become habit for many to spend more than they have. As a result, overall U.S. credit card debt grew by 435% from 2002 to year-end 2007, from $211 billion to approximately $915 billion… As recently as the 1980s, the national savings rate was 10 to 11 percent. Since 2005, Americans have saved less than 1 percent of their disposable incomes. In fact, the most recent figures from March show that the savings rate is negative, below zero. And also in March the government reported that for the first time since the Depression, Americans owe more on their homes than they have in equity. Essentially, on average, America is broke and its credit cards played a dominant role in getting there.”

I suppose it’s inevitable that there will be some negative consequence from America’s stubborn chase after foolishness. It’s debatable whether the consequences will be to the completely ruinous extent this article claims is possible. Regardless, in the end, it’s up to each individual consumer to act wisely now (i.e., spend less, save more) and determine how badly they will be affected by the fallout.