The coronavirus financial crisis has so spooked card issuers that many are lowering credit limits even for the most creditworthy cardholders. Mohamed Dabo reports.
Economic uncertainty and low risk tolerance have led banks to slash credit limits and tighten credit standards, just like they did during the last financial crisis.
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Indeed, conditions during the covid-19 pandemic are not altogether dissimilar to those of the Great Recession in 2008. Mortgage lenders, for example, have already raised credit score and down payment requirements and paused home equity lines of credit.
“Looking back to the Great Recession as a guide, the October 2008 Fed Senior Loan Officer survey found 20 percent of card companies cut credit lines for customers with prime credit scores and 60 percent reduced lines for subprime cardholders,” said Ted Rossman, industry analyst for Bankrate.
“Banks are once again very nervous about the state of the economy and the job market, and they’re pulling back on their risk exposure,” he added.
Most people don’t realize how much freedom credit card issuers have to cut limits or even cancel cards without warning, Rossman said.
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By GlobalDataWhy issuers do it
Reducing the amount of money that cardholders are able to borrow is one way in which banks look to mitigate their risk during times of financial uncertainty.
Typically, your credit limit is determined by a number of factors found on your credit report and credit card application, including payment history, income and credit utilization, among others, though some credit cards have standard credit limits that are extended to every cardholder.
Many issuers may also increase your credit limit over time or grant higher credit limits upon request.
But when consumers face job loss, business closure and financial hardship during an economic downturn, they may be forced to borrow more money than they can afford to repay, leading to an increase in account delinquencies.
Decreasing the amount of credit available to cardholders is one way for issuers to reduce this risk.
What cardholders can expect
Credit card issuers may be more likely to cut A credit line if the cardholder increases spending, has a subprime credit rating, or uses a hardship programme to skip payments.
But even those with decent credit could be at risk.
“If you start carrying more debt, credit card issuers become worried that you’re in a financial crisis,” said Beverly Harzog, credit card expert and consumer finance analyst. “Right now, that alone is understandable. But if you’re also opening several new cards or getting personal loans, the issuer might cut your limit to decrease their own risk.”
A layoff or pay cut may mean that a cardholder needs to use their card issuer’s hardship program. But If they enter a hardship programme, the issuer might assume that the cardholder will struggle to pay your card balance and take steps to limit losses.
Those might include cutting or suspending use of your credit line.
If a creditor makes a major change to an account, such as reducing the credit line, the cardholder will receive a written notice.
The issuer can close an inactive card without notice but may provide warning in case the cardholder wants to keep it.
The effect on the credit file
One the credit limit on a card is reduced, the cardholder should adjust their credit use accordingly, to avoid a negative effect on their credit score.
Your credit utilisation ratio—the amount of credit you use compared to your overall limit—is an important in determining your score. Ideally, your utilisation should remain under 30%, though the lower it is, the better for your score.
If your credit limit is reduced but your spending remains the same, your utilization rate will increase.
In other words, if your credit limit is currently £20,000 and you spend £2,000 each month, your utilization rate is a healthy 10 percent. If your overall limit is reduced to £5,000 and you continue to spend £2,000, though, your rate will increase to 40%.
It’s likely that more issuers will begin pulling back credit limits and impacting card use over the next several months. But there are ways you may be able to reduce the risk of your credit limit being affected.
“Dormant cards are prime candidates for cancellation, so if you haven’t made a purchase on a card in a while, you should buy something small and pay it off right away,” Rossman says.
You should also keep up good credit habits like keeping utilization low and making timely payments each month.
As consumers continue to face the economic fallout from covid-19, the risks of missing payments and increasing debt balances grow. As a result, many credit card issuers will continue to respond by reducing previously extended spending limits and tightening the reins for new customers.
