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COVID-19 has wreaked havoc on our financial security. And, while many financial institutions like banks, credit unions, loan holders, and credit card companies are extending assistance, there is no guarantee on how long that assistance will last. Eventually, it’s going to catch up to us, and there are a few things that I learned from the 2008 housing crisis that I’d like to bring awareness to – namely, how this crisis may effect your credit score even if you do everything “right”.
Having a good credit score will help you get good rates for borrowing – car loans, home loans, student loans, credit card interest rates, deposits on apartments or utility bills. Your credit score pretty much can determine your financial future – at a set moment in time.
There are various scoring models ranging from 300-850, with FICO, (Fair Issac Corporation) being the most widely used. Scores are determined on types of credit, length of credit, payment history, how often you apply for credit, any derogatory marks (bankruptcies/liens/etc.), and utilization ratio – how much of your credit you’re using at any one given time.
The higher your score, the better you look to lenders as someone who can manage their credit.
I’m not going to go into the nuances of the credit scoring system, nor am I going to express my annoyance with the system in general (and believe me, I have issues with this system!) For the purposes of this article, just know that the scoring model exists, and you can get your score, for free, from many banks and credit card companies. Just log into your account, go to “services” and see if they have an option for viewing your FICO score. (If they don’t, call them directly and see if it’s hidden elsewhere.)
If you want a free copy of your credit report – this is a multi-page document that reveals all of your past credit accounts and loans, along with reported job history and addresses – you can get that for free once a year through each of the credit reporting agencies: Equifax, Experian, and TransUnion.
A very interesting thing started happening with lenders in 2008 as we were heading into the housing crisis. Many credit card companies were cutting the spending limit of their cards – even to individuals who were paying in-full and on-time. This happened to me, personally.
I had a credit card that, at the time, had a $15,000 limit. I’m a pretty frugal person, so there was no way I would ever reach that limit. On average, I spent maybe about $1500/month on that card. I received a notice from the credit card company, telling me that they were “mitigating their risk”. There were people who had been charging up their cards, but not paying their bills (understandable during a crisis), and so by limiting the amount of available credit, the credit card company thought I wouldn’t become one of those people. And so they slashed my limit to $10,000. That didn’t bother me, because, again, I only spent around $1500/month, so no big deal.
Then, a few months later, I got another notice – they were slashing my limit to $8000.
And then, a few months later, yet another notice – this time, going down to $5000.
And finally, a few months later, I got the last of these notices, telling me that my limit would be cut to $1500.
Which, again, that’s about what I spent. It was annoying not to have the extra wiggle-room in case I needed to go over $1500, but I wasn’t overly concerned. Until I saw the effect on my credit score.
One of the determining factors of your credit score is your “utilization rate” – your debt to available credit ratio. Ideally, you want to be under 30%. If I had a limit of $15,000, and my “debt” on that card was $1500 that’s a 10% utilization rate – a very healthy place to be.
If my limit was $8000, with a $1500 balance that creates a 18.7% utilization rate. Still, not bad.
At $5000, my $1500 balance creates a 30% utilization – and now I’m in the “danger zone” of not being a good risk for extending credit or receiving a decent interest rate on loans.
Do you see where I’m going with this?
With a $1500 limit, and a $1500 balance – that’s a 100% utilization. My credit card companies now view me as high-risk and then jacked up my interest rates. At the time, I had an interest rate of 9.99% on that card. Because of my utilization rate my credit score dropped to the low 600s (it had been in the high 700s) which then jumped to 24.99%. Keep in mind, this started happening across all of my cards. Again, I hadn’t defaulted on my cards, loans, or done anything “wrong” – this situation was created by the credit card companies themselves.
Luckily, I generally don’t carry a balance (I do take advantage of the 0% offers when they come though!) But not everyone is in a financial position to pay off all of their cards each and every month – especially during a pandemic!
I haven’t heard of this situation popping up during COVID-19…yet. But I think it would be highly naive of us to think that it wouldn’t happen again. So, just be prepared. If you have to fall back on credit cards during this pandemic, do the best to pay off your cards before the close date so they don’t appear on your report and keep this story in the back of your mind – especially if you need a good credit rating for a future need.
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