Covid-19 and Credit

August 7, 2020
Shawn Lane
Consumer Credit Expert

Credit is a game of trust. Lenders trust borrowers to pay their bills on time, and borrowers trust lenders to make good on the lines of credit they’ve extended. When times get tough, that trust is put to the test.

As the economy continues to struggle due to fallout from the Covid-19 pandemic, lenders are shifting to a more conservative approach when it comes to credit cards and other credit offerings. In some cases, that means cancelling accounts that would have otherwise been left alone. So what does this mean for the average consumer, and how can concerned borrowers prevent these new measures from affecting their credit score?

Read below to find out.

What Credit Card Companies are Doing
Due to the recent recession, many credit card companies are reducing credit limits and cancelling accounts. This is a preventative measure to limit their exposure to customers who may default on their accounts. It’s similar to what many lenders did during the 2008 housing crash.

Unfortunately, lower credit limits and closed accounts can have a major effect on an individual’s credit score. When a credit card company reduces your credit limit or closes your account, this will increase your credit utilization ratio, or how much of your available credit you’re using. A higher ratio may result in a lower credit score. The credit utilization ratio makes up 30% of your credit score and is the second most important factor. A canceled credit card can also negatively impact your credit score in other ways. A cancelled credit card may impact your mix of credit which accounts for 10% of your credit score, because you will have one less open account on your credit report. In the longer term, a cancelled credit card may impact the age of your credit file which accounts for 15% of your credit score, if it is one of your oldest accounts.  However, this impact will be years down the road, as positive credit will stay on your credit report and be part of your credit history for 10 years.

What to Do if Your Card is Closed or the Limit is Reduced
First, calculate the credit card utilization ratio for each of your cards. While many consumers believe that a 30% ratio is the maximum you should have, most credit score models will ding you if the ratio is 10% or more. Add up the total balance for each card and divide it by the credit limit. You should pay off enough of the balance to come in under 10% utilization. Some people will set reminders to check their credit balance halfway through the billing cycle to ensure their ratio stays below that threshold. Next, make sure that all your bills are paid on time. On-time payments are the most important factor and account for 35% of your credit score.

If you’re worried about missing a payment, always contact the lender beforehand. They may have deferment or other options available to customers in good standing. Lenders always prefer working with you now over collecting from you later, so don’t be afraid to get in touch. If they do offer deferment, make sure you understand the terms of the deferment. Some lenders may tack on a few extra months to your initial term, while others will require a balloon payment. You should know what you’re getting into before you sign up.

What is the FICO Resilience Index?
Announced in June 2020, the FICO Resilience Index measures the probability that an individual will miss a payment or default on a debt. Lenders and creditors can then use that information when deciding whether or not to extend more credit. The index ranges from 1 to 99, and those between 1 and 44 are rated as being “more resilient.” Those with more resilience will have an easier time accessing lines of credit, because lenders will see them as more trustworthy and financially stable. Like a high credit score, those with a high Resilience Index will have fewer credit inquiries, a lower revolving balance and a higher average credit age. If you want to increase your resilience rating, avoid applying to new loans or credit cards, keep paying your bills on time and reduce your utilization ratio.

Ready to make a plan to reach your credit goals? Schedule a free credit analysis with a Financial Renovation Solutions credit consultant today.