The folly of relying on credit to save your fiscal butt

I've long advocated building up an emergency fund and/or "rainy day fund" if at all possible, to help get through hard times if and when they arrive.  However, I know many people who've dismissed that advice.  They've said they simply can't afford to do that on their income, so they'll rely on credit cards and other debt instruments to cover expenses if something goes wrong.

Well, they're now running headlong into the reality of the financial markets.  A lot of them are finding that the credit lines they'd planned on using are either less than they'd expected, or aren't available at all.  For a start, credit card issuers are reducing their exposure to potentially bad debt.  Everyone except those with stellar credit ratings and history is at risk.

A new survey has found that about 25% of card owners in the US had their limits reduced or accounts closed within the past 30 days.

Almost 50 million people saw their credit limits decreased or cards closed involuntarily, according to a CompareCards survey conducted in late April.

There's more at the link.  Bold, underlined text is my emphasis.

To make matters worse, credit limits on credit cards can be adjusted by their issuers without specifically notifying card-holders.  Your only notice will be the changed credit limit printed on your monthly statement - and many don't read those in any detail.  That means you could find yourself suddenly maxed out on your credit card, without any prior awareness of that risk.

That new wariness by lenders is extending even to secured debt such as mortgages and home equity lines of credit (HELOC's).

Over the past month, lenders have put in place higher credit-score and down payment requirements, and in some cases stopped issuing certain types of loans altogether, in effect shutting down a large swath of the mortgage market ... The impact has been dramatic, with one model showing mortgage credit availability has plunged by more than 25% since the U.S. outbreak of the virus.

. . .

JPMorgan Chase & Co. tightened its standards last month, requiring borrowers to have minimum credit scores of 700 and to make down payments of 20% of the home price on most mortgages, including refinances if the bank didn’t already manage the loan.

Wells Fargo & Co. increased its minimum credit score to 680 for government loans that it buys from smaller lenders before aggregating them into mortgage bonds.

The banks’ revised standards are far above the typical minimum score of 580 and down payment of 3.5% that borrowers need to qualify for home-buying programs supported by the federal government.

Wells Fargo is no longer letting borrowers refinance their mortgages while cashing out home equity, and both Wells and JPMorgan have suspended new home-equity lines of credit.

Again, more at the link.

That's potentially very bad news indeed if you were relying on a HELOC, or planning to cash out some of your equity in your home, to get you through the present crisis.  For example, if you own more than 50% equity in your home (i.e. the outstanding balance on your mortgage is less than 50% of your home's current market value), you might have planned to draw on that in a financial emergency (such as many of us are facing in these difficult times).  However, now you won't be allowed to access that equity through a HELOC.  That's going to put a big crimp in some people's ability to cope.

I've even heard from some friends that their existing, pre-approved HELOC's have been "frozen" or suspended at their present levels.  For example, they may have been approved for a $25,000 HELOC, but they're only using, say, $12,000 of that facility.  Now they're finding that they can no longer access the remaining balance of the credit they'd already arranged.  That's proving to be a huge financial headache for them.  I know a few who are applying for second mortgages, with different lenders, to make up the sudden shortfall - but that's costing them a lot more in fees and higher interest rates.  Worse, in the present economic climate, sometimes second mortgages are simply not available.

One can't blame lenders for seeking to protect themselves, but if you rely on credit to make ends meet from month to month, that doesn't help you at all.  As I've said so often in the past (for just one example, see here), get out of debt if at all possible, and stay that way!  That's investing in your own future, in the best possible way.  Also, build up some sort of emergency fund as soon as possible.  In fact, I'd go so far as to suggest, if possible, using your government coronavirus stimulus checks to start such a fund, rather than using them to pay off debt or cover other needs.  If you have no emergency financial "cushion" at all, that'll be a whole lot better than nothing.

Some people have told me that they haven't bothered to build up their own emergency "nest egg" because they'll be eligible for unemployment, or some other form of social welfare or entitlement program, if they're laid off or their employer goes bankrupt.  Er . . . not so fast.

People in many states, including New Jersey,  Maine, and Pennsylvania report they haven’t yet gotten a dime from unemployment. In fact, a whopping 71% of jobless Americans haven’t gotten their unemployment payments from March.  Lines at food banks are literally miles long in some areas.

Without a nest egg, and with your usual credit facilities now circumscribed, you may find yourself in the same boat - unless you have something set aside for a rainy day.

If you're still doubtful about the need (or possibility of saving) for an emergency fund, see Aesop's latest.  Scroll down to point #3, and read it.  Slowly and carefully.  Yes, he's talking to you.  Then, go back and read the entire article.  He makes good sense, and underlines everything I've had to say on the subject for the past twelve years or so on this blog.

Peter