The Credit Crunch and You

The pending bailout is not just about saving Wall Street, it is also about saving the economy from spiraling down into a deep recession. The problems on Wall Street have already started dragging Main Street down with it. There is so much fear in the market right now, banks are not lending to anybody - individuals, companies and each other.

The rate banks charge each other for loans (the LIBOR - the London Interbank Offered Rate) has shot up overnight. For example, the 3 month LIBOR is at 4.05%, up from 3.88% and the rate banks charge each other for overnight loans is at 6.88%.

The Federal Reserve has been doing its part to ease the crunch by pumping money into the markets to provide liquidity but banks just aren’t lending because they are scared to lend.

All types of lenders had already been raising the bar for borrowers and were only lending to the best customers. With the uncertainty of the bailout they became even less willing to lend their money, further crimping the crunch.

Banks are even cutting back on credit cards and lowering the credit limit on borrowers, further squeezing borrowers. American Express has lowered the credit limit on about half its credit card holders. Amex is also offering fewer credit cards in areas where housing prices have fallen the most, which includes California, the southwest and Florida.

How does this affect you?

Need a mortgage or home equity line of credit? 

• Lenders are raising the bar for qualifying for a mortgage, most banks are once again requiring a 20% down payment.
• Loan Debt To Income has been lowered, your monthly loan payment should be no more than a certain percentage of your income, meaning you now qualify for less then you would have in the past. You can use this GinnieMae Affordability calculator to see how much you qualify for.
• Banks are also requiring higher credit scores to qualify for a home loan.
• Home equity lines of credit have been canceled or reduced as home prices have fallen.

Worried about being laid off?

Many companies fund their day to day operations and grow using short term credit. They accomplish this by selling short-term and long-term bonds in the credit markets. Right now, the short-term debt markets are at a standstill and the long-term debt markets are a bit more functional, but rates are high.

Companies with high levels of debt will be the first ones in trouble, but even companies with low levels of debt might have to resort to layoffs if they can’t get access to credit and the economy stalls.

What can you do to survive the pending credit crunch?

Start a budget and fund an emergency fund (if you don’t already have one).

1. Take inventory of your financial situation by making a list of all your income and expenses to know where you stand.
2. Expenses: There are basically two types of expenses - fixed cost and variable cost.  For example, your mortgage payment is the same every month but the amount you spend on food varies.  Shop fixed costs where it’s possible (like car insurance) and find ways you can cut back on variable costs.  Look for areas where discretionary spending can be curbed without causing too much discomfort or distress.
3. Subtract your expenses from your income. This is your budget starting point. Think about a dollar amount you would like to have in an emergency fund and save every month towards your goal. Experts recommend 3 to 6 months of expenses to tide you over in the event of a job loss.  
4. Try trimming your expenses, eat out less, shop around for cheaper car insurance. If you take the time to keep track of a budget you will be surprised how much you can cut back and still feel like you are living. Before you make a purchase, ask yourself, “Is this a need or a want?” When you clearly define needs and wants, making purchases is easier and you won’t feel guilty making certain purchases.
5. If you are staying within your budget, treat yourself from time to time, the pain of staying within a budget will be easier.

Another way to survive this uncertain economic period is to make sure your bank deposits are within the FDIC insurance limits.

The Certificate of Deposit Account Registry Service (cdars.com) allows you to deposit up to $50 million in Certificate of Deposit accounts. You earn the same CD rate across all banks your money is deposited in.  

Here is a MarketWatch.com video on spending less and saving more.