Credit scores aren’t the only thing getting hit amid the COVID-19 pandemic — so are the limits on credit cards.
With millions of Americans out of work, credit issuers are reducing their risk by lowering credit limits. According to one study, 25% of credit card holders, or 50 million individuals, saw their borrowing capacity reduced or — worse — their credit cards closed with no notice last month. While that would be bad in normal times, it’s made worse during the pandemic when people are relying on credit cards to get food on the table and gas in their cars. Of cardholders surveyed, three out of 10 said they are using their credit cards more than ever.
The banks’ move is not without precedent. During the Great Recession of 2008 and 2009, credit issuers did the same thing. Fearing record defaults, they reduced the amount that consumers and businesses could borrow. “It was pretty brutal, especially for small businesses,” says Erik Knight, CEO of SimpleWAN, the business networking company. “What people really don’t understand is your credit score is based on your outstanding limits. If the bank cuts your credit limit, you look much more overleveraged.”
When determining your credit score, the credit scoring agencies look at several factors including your credit utilization rate, which is your outstanding balances compared to your credit limits. The lower the percentage, the better. It’s an important factor in determining how much it will cost you to borrow, second only to payment history. Let’s say you had a credit card with a $10,000 limit, and you kept a $3,000 balance. You look good in the eyes of lenders because your credit utilization rate stands at 30%. (Keep in mind that 10% or lower is ideal.) But if your limit gets cut in half by your creditor, at $5000, you’re suddenly too close to your credit line – and your credit scores will take the hit.
Utilization, Payment History Weigh Heavily in Banks’ Decisions
Banks aren’t being indiscriminate with their actions. They are taking a measured approach to whose limits they reduce and by how much. They’re looking at recent payment history, credit utilization and other signs you may be experiencing financial difficulties. “They don’t just take a machete and start swinging randomly,” said Bruce McClary, a spokesman for the National Foundation for Credit Counseling. “They are limiting their risk.”
According to the CompareCards survey, of the Americans seeing their limits reduced, it’s spread out almost evenly among Generation Z, millennials, and Generation X at around 35% each. Baby boomers are faring much better, with just 8% seeing a reduction. Men are getting hit harder than women, with 37% seeing limits cut compared to 12% of females. It’s not just affecting people struggling to put food on the table. Of those polled, 36% made $100,000 or more.
With Little Heads-Up, You Have To Be Proactive
Adding insult to injury, in most instances banks aren’t required to notify you when they reduce borrowing capacity. That means you could end up checking out at the grocery store only to find you don’t have the credit to cover it. To keep that from happening, McClary says to be proactive with creditors, especially in the current environment. Banks understand what consumers are going through and may be open to reconsidering if you make a good case. Even if they don’t let you borrow more, they may be willing to work with you to get the balance paid off either through a deferment or payment plan. “You can’t put the toothpaste back in the tube if you missed a couple of payments, but it’s still worthwhile to reach out and talk to your creditors about why they did this,” says McClary.
If that fails and you need your credit cards for basic goods and services, experts say to spread your purchases across a handful of cards to get through the hard times or request a limit increase on another card. If you have a decent credit score, consider opening an additional card or taking out a personal loan. Andrea Woroch, a money-saving expert says you may be able to do better with a personal loan compared to a credit card. Be mindful that you’ll still have to pay interest — not ideal but necessary for millions during these unprecedented times.
There are also food banks and other community services that struggling consumers can turn to. “Be proactive and do everything you can to avoid a situation where you run out of credit and have no cash,” says McClary. “Use all the resources available to meet your most basic needs during these difficult times.”