Credit card limits are being slashed without warning as banks minimize risk, but the practice hurts credit scores. Think Stock photo.

A final round of new credit card rules designed to protect consumers goes into effect on Aug. 22. Banks and credit card companies have been raising interest rates and fees and slashing credit limits in the run-up to the new credit card rules. Slashing credit card limits is a common practice during economic hard times. But cardholders’ credit scores get hurt by it, through no fault of their own. But there are steps credit card users can take if they want to preserve their current credit limits, or even boost their credit limits.

Credit card limits slashed across the board

Credit card companies have been cracking down on cardholders during the recession and its aftermath. Many credit card-issuing banks are trying to rein in risk amid rising delinquencies and charge-offs — and before the final round of new credit card rules goes into effect. Bankrate.com reports that even cardholders with good credit scores are getting their credit card limits slashed. Dennis C. Moroney, research director of bank cards at TowerGroup, told Bankrate that credit card companies are reducing credit lines and closing accounts. He said that even people with higher scores that have been cut down from 750 to 720 are having trouble getting credit.

Credit limit cuts hurt credit scores

More than 60 million cardholders have had their credit limit slashed over the past few years. Credit Card Guide reports that many people hit by credit limit cuts haven’t committed any  of the typical “risk triggers” banks use to assess credit worthiness, such as regular late payments or high credit card balances. Credit limit cuts aren’t just a major inconvenience. For cardholders with outstanding balances they can hurt credit scores as well. With the debt-to-credit ratio weighing in second among the most important factors contributing to credit scores, credit line cuts are no small concern.

How to protect your credit card limits

For cardholders who want to keep their current credit limit and perhaps even get a credit line increase, Eva Norlyk Smith at Credit Card Guide offers tips. First of all, simply call and ask. Most credit card accounts are eligible for credit limit increases once a year. Always pay off the balance in full every month. And use the credit card a lot, but don’t exceed 50 percent of the credit line. Always send in the payment on time. Don’t cancel any credit cards, don’t apply for any new credit cards and never ask a credit card company to pull your credit report. A credit check hurts a credit score as much as applying for a new credit card.

A secured credit card is a good way to reestablish credit. Even for those who do not have a bad credit history, a secured credit card can be a safe way to control spending and avoid bad debt. Knowing exactly what these cards are and how they work helps people make sound financial decisions about their credit.

What is a secured credit card?

Some credit card companies actually exist to help people repair bad credit and control spending. They do so by offering people an opportunity to make a cash deposit in exchange for a credit card that will be secured by that deposit. The credit limit offered generally ranges up to 120 percent of the original deposit. This deposit also earns interest as long as the account is in good standing. Timely payments are reported to the credit bureaus, which can help people seeking to reestablish a good credit rating. Also, the credit bureau’s are never told that the credit card is secured and, therefore, it is featured on one’s credit report as any other credit card would be.

What happens if I default on the payments?

The reason that secured credit cards are considered safe is that defaulted payments are covered by the initial deposit. Late payments are also reported to the credit bureaus, which further damages a poor credit rating. Even with a deposit, people using a secured credit card must be responsible about paying their credit card bill every month on time.

How can I increase the limit on a secured credit card?

As discussed above, a person’s spending limit is set on a secured credit card in relation to the initial deposit. There are two ways to increase one’s credit limit, however. The first way involves adding to the deposit amount. Or a person can patiently await a second option, which involves an increase after accomplishing a good payment history during a set period of time, which is generally one year.

Interest rates and fees

Consumers with bad credit will most likely encounter higher than average fees with a secured credit card. Most also require an upfront processing fee and the annual percentage rate for a cash advance or for balances can also be high. However, the price for reestablishing good credit is usually worth the additional costs for people who use secured credit cards.

Cost, convenience, credit

While a secured credit card is more costly than a regular credit card, its reward is something that cannot be obtained in too many other ways. Those who have bad credit generally appreciate that such offers exist and many have made good use of them as credit recovery tools. The fact that they are not represented to others as a secured credit card is also a convincing factor to people, as they are able to rent cars, reserve hotel rooms and use them just as any other credit card as long as the spending limits are adhered to.
Because they require a deposit and credit limits are restrained by that deposit, some people find them to be inconvenient. Another way to view them, however, is to consider that a credit line that is limited, or secured, by a deposit helps to decrease the risk of overspending. As much as reestablishing credit, this simple fact makes a secured credit card an attractive choice for those who have had poor spending habits and a history of collecting bad credit card debt.

HELOC stands for Home Equity Line of Credit. It’s a credit line offered by a bank with the borrower’s property equity serving as collateral for the loan. The equity is the difference between the market value of the property and the amount still owed on mortgages or other encumbrances.

For example, if you owe $70,000 on your house and the market value is $250,000, your equity value is $180,000. On the basis of this equity the lender is normally willing to offer a HELOC that the borrower can draw against for five to ten years, with a repayment period of up to twenty-five years.

Should HELOC be considered a type of credit card or a loan?

A HELOC is essentially a hybrid between a credit card and a second. Like a credit card, the lender allows you to spend up to a certain limit (i.e., the amount of the equity) and you only have to pay according to the amount of credit used. Each time credit is taken up the amount of credit available declines, but it increases again with repayments. However, unlike a credit card the HELOC is a secured debt.
The pledging of real estate as security makes a HELOC similar to a second mortgage, but there is a key difference. When a second mortgage is obtained, the lender gives the borrower the entire loan amount in a lump sum, but with a HELOC the loan is taken out on an installment basis according to the borrower’s needs.

What are the advantages of a HELOC compared to other kinds of loans?

The chief advantage of a HELOC is its suitability for infrequent but major expenses in a household budget. Common examples include financing a home addition, and paying for a child’s college tuition or wedding expenses. With the current, low prime interest rates HELOCs can provide inexpensive financing. Another significant advantage is the fact that borrowers may quality for tax deductions on HELOC repayments.
For some borrowers, the HELOC can provide an economical means of debt consolidation. You might find it significantly cheaper to pay the interest on the HELOC rather than to continue paying several lenders their interest charges, administrative costs and delayed payment penalties.

Disadvantages of taking out a HELOC

The attractiveness of taking out a HELOC in certain circumstances needs to be balanced against the risks. If the HELOC carries a variable interest rate, Borrowers should be aware that interest rates can change to their disadvantage. Furthermore, if they fail to make repayments, they may ultimately lose their homes.

If you decide to use a HELOC to consolidate debts, remember that it is common for banks to charge closing fees for paying off their loans and this expense should be taken into account when calculating your expected savings. With some HELOCs personal liability for any deficiency remains even after the bank has foreclosed on the secured home. Another risk is that banks have the right to terminate an unused credit line if a decline in property value reduces the borrower’s equity.