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Fear of Chargeoffs and Default Nudge Credit Card Companies to Reduce Max Credit Limits
At a time when Americans are struggling to pay bills and are relying more heavily on credit cards to float debt, some credit card issuers are reducing the max amounts their card holders may charge. Not only is this limiting how much their card holders can charge, but it also pushing some card holders over; or near, their max limit and reducing scores.
For example: Elaine has a credit card with a $10,000 credit limit. Currently she has a balance of $6,000 charged on the card. At this juncture she still has another $4,000 she can charge and she is well beneath her max credit limit. But then her credit card issuer reduces her max credit limit from $10,000 down to $7,000. Now Elaine is within $1,000 of reaching her max credit limit. Elaine's car transmission goes out and she is hit with a $1,500 emergency auto repair expense that she cannot pay because she doesn't have the cash. What's her recourse? She charges the expense to her credit card and is now over her credit limit. Not only does her credit card company charge her a fee, but her credit report score also takes a hit. The reduction of her score leads her card company to raise her interest rate, and soon her other creditors also raise the rates they charge Elaine.
Are the credit card companies simply being greedy and are to blame for this new wave of consumer problems?
Not exactly.
So why are some credit card companies reducing credit limits?
Their action is in response to an ever-declining economy and the growing high risk of card holder default (racking up a lot of charges and not repaying). Although recent bankruptcy laws slowed-down the rush of bankruptcy filings, Americans still have the option of simply not repaying debts, or negotiating settlement (credit card chargeoff) for less than what's owed.
Some cardholders who had their limits reduced might not even know it until they apply for a loan or another credit card, and then get denied (or get approved but at astronomical interest rates) because their credit score has dropped.
Yet no one can fault banks and other card lenders for trying to better protect themselves against high risk and massive losses like those they've suffered from bad credit loans. As a result, they are looking for ways to reduce their exposure to cardholders more likely to default. That's why they are lowering credit limits, which means they are reducing the maximum amount of credit extended to an individual, along with boosting card interest rates and allowing fewer balance transfers.
According to John Hall, a spokesman for the American Bankers Association (a Washington-based trade group): "This is what they have to do at this time."
Such moves come as consumers are increasingly using their credit cards as a source of liquidity, especially since it's becoming harder to tap their home equity as much to pay for everything from renovations to vacations to trips to the mall. As the housing and mortgage markets have collapsed, lenders have also reduced the limits on what are known as home equity lines of credit, or HELOCs.
Net home equity extraction fell nearly 60 percent from a year earlier to $205 billion in the first quarter, according to Merrill Lynch. The investment bank also notes that some $1.2 trillion in equity and housing wealth was wiped out in the first quarter alone because of plunging home values.
At the same time, revolving credit usage - which includes credit cards - accelerated sharply to a year-over-year growth rate of about 8 percent in recent months. That's the fastest rate in seven years and well ahead of the 2 to 3 percent rate of growth from 2004 through 2006 when home equity lines of credit were a bigger source of cash for consumers, according to Merrill.
But as credit cards are used more frequently, that often results in bigger balances left on the cards. What's worrisome is that consumers who are faced with a number of ugly economic scenarios hitting at once - falling home prices, surging commodities costs and a weak job outlook - won't be able to pay their bills.
American Express warned Wednesday that more of its customers were falling behind on their payments. That led some Wall Street analysts to forecast that the card company may soon lower its predicted earnings growth for 2008.
"Business conditions continue to weaken in the U.S. and so far this month we have seen credit indicators deteriorate beyond our expectations," American Express' CEO Kenneth Chenault said in a statement.
That's why card companies including Washington Mutual, HSBC and Wells Fargo are lowering their credit limits, according to data from the consulting firm Institutional Risk Analytics.
Consumer advocates aren't saying that is bad news - in fact, they believe it helps prevent cardholders from overextending themselves and is preferred to having a sudden surge in card interest rates.
"In the purest sense, it is the better way to manage the risk of a cardholder," said Linda Sherry, director of national priorities for Consumer Action, a national non-profit consumer rights and education group. "But a low credit limit can also unknowingly hurt a credit score."
Here's how that happens: Let's say a cardholder has a credit limit of $10,000 and a balance on the card of $4,000. The card company worries that large balance may increase the prospects for default, so it lowers the credit line to $5,000.
But in doing that, it completely changes what is known as the credit utilization rate, raising it from 40 percent to 80 percent. That is then factored into the calculation of one's so-called FICO credit score, which measures creditworthiness, according to Craig Watts, a spokesman for FICO-creator Fair Isaac Corp.
A lower FICO score could make it more expensive for someone trying to borrow money. For instance, someone taking out a $25,000 36-month auto loan would see an interest rate of about 6.4 percent and a monthly payment of $765 if they were in the highest range of FICO scores of 720 to 850, according to Fair Isaac's Web site myFICO.com.
That then jumps to an interest rate of 7.3 percent and a monthly payment of $776 for those with a score of 690 to 719 and as much as 15 percent or $866 a month for those with the lowest FICO range of 500 to 589.
According to the Comptroller of the Currency, one of the government agencies that regulate U.S. banks, companies must notify cardholders at least 15 days in advance before making changes in the terms of their account, such as lowering the credit limit. But they don't have to explain how that could change an individual's credit score.
That puts the burden on consumers to watch out for this. They better so they don't get blindsided.
Negotiating Bank Charges
If you find a new fee charged to your account:
Don't get complacent. Part of the reason so many customers end up paying fees is they don't contest them. If fees show up on your account statement and you don't agree, call the bank representative. In most cases, if you are a good customer, banks will give you a break.
Call on weekends. Few managers work on weekends, and it may improve your chances of getting the fee excused if the manager is not around.
Do your research before you place that call. Find out just how valuable a customer you are to the bank. Figure out your average monthly credit card balance. If you have more than one card, then figure out the balances on those. If it's a debit card account, write down your average monthly checking balance. Be prepared to say how many years you have been a customer. Use these numbers as ammunition on the bargaining table.
Be realistic about your time. If the charge is for $2, is it really worth it to spend 20 minutes on the phone to get it reversed? Save your time and energy for those $25 charges.
Also, remember to be polite and not lose your temper. Bank representatives are more likely to help you if you are nice to them.
Get more information about; or to apply for, debt settlement, credit card debt consolidation or credit counseling.
Or browse and submit an online credit card application including cards for good and bad credit.
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