Previously Issued Credit Lines Increasing Overall Debt Load

Banks were loaning money at a fast pace in the early months of this year, in spite of telling the Federal Reserve that they were tightening loan standards and demand for loans was down. They weren’t doing it on purpose – but at that point, they had no choice.

What gives?

Consumers and business faced with the impossibility of getting new loans combined with shrinking limits on their credit cards have been using previously issued lines of credit.

This is especially prevalent in commercial and industrial applications, because many companies that had financed themselves through commercial paper had paid for backup lines of credit. The banks didn’t expect that those lines would ever be used.

Home owners are also tapping in to previously committed funds. When it suddenly became much more difficult to refinance home mortgages, they began maxing out their credit cards through cash advances or drawing on HELOCs – Home equity lines of credit.

Many consumers had obtained HELOC’s for an amount greater than they needed at the time – because the line of credit was tied to their equity in the home, and because they paid no interest unless they drew out funds, it made perfect sense to do so.

These lines of credit were a “safety net” of sorts – there in case of an urgent need. And 2008 has brought urgent need to many.

According to a report in the New York Times, the six month period ending in March saw overall debt grow faster than at any time since 2005, when credit approval standards were very low.

The result – banks are now moving to reduce as many outstanding lines of credit as possible. They’re reducing limits on credit cards and home equity lines alike – and refusing to renew credit cards that have expired.

The shock for some consumers was what happened when they took a cash advance on a credit card. This act triggered some cards to suddenly reduce their credit limit to match their outstanding balance – which meant they were over limit when the month’s interest was added on. Then, because they’d gone over limit, the credit card issuer was free to raise their interest rate – giving them a double whammy.

While many are taking steps to move or eliminate this debt, others have simply said “I give up” and stopped paying credit card bills.

While more recent statistics are not yet available, we can assume that overall debt has risen drastically as more and more consumers have stopped paying credit card bills. Even with no new charges, credit card companies impose both late fees and over limit fees each month – and hike the interest rate to the maximum. Balances can double or triple in a short time.

These additions will affect reports of overall debt during the coming months, as analysts will not know how much is “deliberate” debt initiated by consumers, and how much is due to fees tacked on by credit card issuers.

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