During these times of uncertainty, banks and credit issuers are cutting credit limits without any advanced notice. This change can quickly affect your credit score and how you use your credit card as a whole. This change won’t just affect our current credit cards, but how we apply and get approved for credit in the future as well. Banks will have to become more strict on credit limits, income verification, and outstanding borrowers’ debt. A change within the credit lending business is coming whether we like it or not. I share this with you so when hard financial times come you know why certain industries and services are changing. So, let’s go into why these banks are taking these drastic measures of cutting credit limits.
Why are banks lowering credit limits?
Why would banks even bother lowering credit limits? Well, the truth is they’re mitigating their risk of people defaulting on credit card payments by reducing how much they lend out. They’re aware that a lot of people might jump deep into debt to make ends meet during hard economic times. The banks want to make sure their not handicapping people into debt they’re not able to possibly payback. Which would be bad business for all parties.
Now, historically banks have lowered credit limits during other hard economic times like the 2008 recession. Once one bank pulls the trigger of lowering credit limits, interest rates, or increasing requirements, the domino effect starts the happen. The banks are aware of the economic conditions in their industry and have the right to make necessary changes to keep business going. This is why it’s so important we take the necessary steps to check our credit limit and make sure we don’t overextend ourselves. I say this because you most likely won’t know that your credit limit was reduced until it’s in effect. At the point, your bank will send you a letter to inform you of the changes to your account.
Credit limits and Emergency Funds
When it comes to credit limits and emergency funds, you know I have something to say. It’s been promoted by some financial experts that your credit limit can be part of your overall emergency fund. But when you see how much control banks have over our credit limit, this has to make you feel a certain way. This positions minorities and nonpreferred borrowers at a horrible disadvantage during hard times. Why? Because these are the people who will have less access to funds during an emergency and have their credit scores most affected.
Now, how do emergency funds tie in with credit limits? It makes your credit limit unreliable, which is exactly the opposite of what you need during an emergency. You want to feel financially confident that you can handle any emergency regardless of an economic recession or pandemic. The best way to balance these two is to allow the cash in your emergency fund savings account to be your main safety net. While you allow your credit limit by the amount you can swipe for during an emergency.
How will a lowered credit limit affect my credit score?
A lowered credit limit can easily affect your credit score since it ties closely to your spending habits and your credit utilization. No matter if you carry a credit card balance or pay it off in full each month, the amount you charge on your card matters. Why? Because all of these charges are considered revolving credit, which means how much credit you use. Having a lowered credit limit affects the calculation of your credit utilization, which equals to 30% of your credit score.
Calculate credit utilization
Let’s do a quick example:
If you spend $1,000 on your credit card per month and your credit limit was $5,000. Then the mathematical equation to figure out your credit utilization would be:
Revolving credit balance / Credit Limit = ______ x 100 = Credit Utilization
Now banks and credit card companies would like your credit utilization to stay under 30% of your credit limit. I personally recommend keeping it below 10%, this way you’re better positioned with your debt.
So, for this example, your credit utilization would be $1,000/$5,000 = 0.2 x 100 = 20%
But let’s say your credit limit was reduced to $2,500 and you continue to spend $1,000 on the card.
Now, your credit utilization would be $1,000/$2,500 = 0.4 x 100 = 40%
That number will negatively affect your credit score and would position those with low credit limits the most.
What can I do if my credit limit was reduced?
Now, if your credit limit was reduced, get on the phone and contact your bank or credit card lender. They may be flexible and able to re-establish your old credit limit. A lot of banks have talked about increasing their credit lending requirements. In the past, they simply requested your personal information, income, and ran your credit. They didn’t do a great job of verifying your income, which resulted in a lot of people having higher credit limits then they should. Moving forward, I won’t be surprised when banks start to request more information to verify your income.
If your bank denies your request to increase your limit and you’ve proven your income. Then you might want to consider a secure credit card. This is simply a credit card that acts more like a debit card while building credit. You will probably have to reduce your spending habits on your current card while using your secured card to help boost your credit score.
The best thing you can do at this moment is to check your credit limit with your bank. Regardless of your credit limit is reduced, you should focus on creating a game plan for your spending. You can do this by mapping out how much you can charge on your card, even if you’re going to pay it off in full. I would also create a debt repayment plan and build an emergency fund for your financial security. This way when dramatic changes happen within the economy you feel better prepared.