Bundle up! ‘Credit Winter’ is coming

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Dear Debt Adviser,
We received notice that if we did not use a credit card we have had for many years in the near future, it would be canceled. Is this a problem since we have other cards and really have not used the card that’s in jeopardy? Does this cancellation affect one’s credit rating?— Vicki

Dear Vicki,
Welcome to the credit crunch. What you are experiencing is the first of possibly a series of contractions in your credit that may end up with you in a vise if you don’t take the right action now.

This is probably happening to my other readers, too. Although you may not have fully recognized it, these are the signs of what I have named the coming “Credit Winter.”

Lenders want two things above all else in the current unstable credit environment: to have less risk exposure and more income. You are among hundreds of thousands of other credit cardholders who have or will receive similar letters in the mail from their creditors.

In this tight credit cycle, creditors will attempt to reduce their risk to new bad loans by taking back as much unused credit as they can. They do this by decreasing credit limits and closing or cancelling accounts that are inactive.

At the same time, interest rates are rising. Teaser rates are flying south in the face of this oncoming “Credit Winter,” leaving your outstanding balances exposed to higher interest and without the range of options you used to have to move them to a less costly card or line of credit.

But wait, there’s more! There is an iceberg floating onto the scene, and like all good icebergs, it is 90 percent hidden. I’m referring to universal default. Under this policy (used by many lenders), if you default on one obligation from anyone, your rates can be raised by everyone.

Universal default may hit you in several ways. For example, imagine your $10,000 limit is reduced to $5,000 on a card with a balance of $4,500. In addition, your interest rate on the card is raised from the current 6 percent to 16 percent. (Because banks have a reduced appetite for new credit, you can’t move the balance to a new card.)

The higher interest rate may make it more difficult for you to make the minimum monthly payment on the $4,500 balance. Come up short on your payment for just one month and you get the Fee Fairy at your mailbox with up to a $39 late charge for you.

Worse, you can be looking at 30 percent plus interest rates if you bounce a check or miss the payment date on a credit card, mortgage or other account. Your interest rate may also increase if you go over your new lower limit or suffer a decline in your credit score as a result of sporting a card balance in excess of 50 percent of the card maximum.

In answer to your credit rating question, 30 percent of your FICO score is based on amounts owed. One component of this category is the amount of credit available versus the amount of credit used, with 50 percent utilization as the negative tipping point.

I strongly urge you to pull out your cardholder agreements to get informed of possible pitfalls ahead. Then, I want you to take a breath and get a bottle of wine.

No, not to forget your troubles! Instead, plan a new course for you and your family that relies less on credit and has an aggressive debt reduction component. Sit down with your wife, partner or the cat, open the wine and set some goals for the next few years. Describe how you want your future to look. Write down the goals. Then put the wine away and get out your calculator.

You need a budget that will allow you to attain goals by consciously directing money to where you want it and not where the ad men do. In your budget, you must include a component for savings. Yes, “savings,” not credit.

Savings will keep you from relying on credit for emergencies that could be coming your way. Unemployment is rising, investments are falling and an unexpected illness or expense could push you over the financial edge. Armed with a budget, savings and a lessened reliance on credit, you will be less vulnerable to economic shocks and other unpleasant surprises.

I have been reading a lot lately about how Wall Street will never be the same again. But I have read very little about how Main Street needs to get ready to adjust to a new credit reality.

I hope this advice alerts my readers to the need to prepare for a basic shift in how we manage our financial affairs.

More savings, less credit — and yes, maybe even some more wine — are part of the new reality. After all, credit is just a tool to get what we want, and there are other means at our disposal if we just know to look for them.