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.

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.

Your credit score is immensely important, not only in your finances, but in life. Insurance costs, job prospects, and homeownership are all affected by this three-digit number. Determined by the Fair Isaac Corporation, thus the name FICO, your credit score has tremendous power over your life.

This is why it’s quite important to understand what makes up your credit score and how you can control it. As the pie chart shows, your credit score is roughly 35% payment history, 30% amounts owed, 15% length of credit history, 10% new credit and 10% types of credit.

1. Payment History

This is fairly self-explanatory — pay your bills on time, every time. Why? Delinquent payments can stay on your credit report up to seven years. If you have problem paying a bill, talk to the lender and update them on how much you can pay and when it will be available. One important note here is that, while everyday bills like utilities won’t go on your credit report, a late payment on one of these can increase your credit card interest rate (i.e., the monthly amount you must pay). Then, you risk falling behind on the credit card payments and your credit report can become marred.

2. Amounts Owed

This category takes into account not only what you owe currently, but what you could possibly owe in the future if you were to max out all your available lines of credit. Essentially, lenders want to know how much you could borrow from all lenders combined, and whether you would be financially able to pay it all back. This speaks directly to your level of risk as a borrower. One solution is to close lines of credit that are paid off and sitting unused, but only if they are newer accounts from within the last three years or so.

3. Length of Credit History

Lenders like to see an established history of not just having credit cards or loans, but having the same accounts with the same lenders over several years. This is why, if you have lines of credit that are paid off and sitting unused, but have been with you quite a while, you should consider keeping them open. Instead of closing it, ask the lender to reduce the available balance to the minimum, then cut up the card and stop using it.

4. New Credit

Try to limit the amount of new credit accounts you open within a short period of time. Also, try to contain credit inquiries (i.e., credit checks run on you for the purpose of obtaining a loan) within a short time period. If you’re shopping for a car or home loan, lenders are going to be checking your credit report a lot. It is gentler on your credit report to get this all out of the way within a couple weeks, as opposed to a couple months.

5. Types of Credit

Revolving credit, like credit cards, should ideally appear on your credit report alongside installment loans, as in a mortgage or car loan. This shows lenders your level of responsibility in handling a variety of debt.

Also, don’t forget to check your credit report often. The best way to get started is to visit AnnualCreditReport.com. A credit check can help correct any reporting errors, as well as identify weak spots in your report and how they might be strengthened.