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.

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.