There is no question that the financial system has experienced a tremendous credit crunch. What is this doing to consumers, the users of credit?
This all started last summer and really accelerated into the fall of 2008 as banks and other financial institutions were on the brink of collapse.
Credit card holders, even those with good credit, started seeing their rates and fees going up and their credit limits reduced. This used to happen to people who had missed a payment or had seen their credit scores go down, but now it is happening to people who have good credit. In fact, it recently happened to me.
What affect do rate increases have on card holders?
If you receive notice of a rate change, you need to call your creditor right away and try to negotiate. If they won’t lower the rate, then you’ll need to consider your options.
You can do several things: 1) you can pay it off 2) you can make a balance transfer to another card (but that may cost you a 3% transfer fee) 3) or you can opt out.
Many card companies are giving customers the right to "opt-out" of a rate increase. If you opt out, the card issuer usually lets you pay off the balance at the old rate but won’t allow you to charge anything else on it. Once you pay off the balance, the card will be closed. And that can hurt your credit score.
So before you opt out, you really need to consider the consequences. Here’s a financial planning tip: If you are going to be in the market for a mortgage or car loan in the next year, consider not opting out so your credit score doesn’t get hurt. Once you get approved for the mortgage or car loan, then deal with that account.
What about lower credit limits, how does that hurt card holders?
Thirty percent of your credit score is based solely on what is called your utilization rate. This is the proportion of the credit that is available to you that you actually use. If you’ve used too much, your credit score will suffer. Here’s an example. Say you have a credit limit of $10,000 with a balance of $2,500. In percentage terms, that means you have used 25% of your credit card limit. That is your utilization rate.
When your limit is reduced, your utilization rate will go up. Using the same example, let’s say your limit is reduced from $10,000 to $5,000. Now instead of having a 25% utilization rate, you have a 50% utilization rate. This could cause your credit score to drop by as much as 50 points. Many people aren’t aware of this. It can really hurt your credit score.
So what did you do in your situation?
I pushed back. This is what I did. I called my bank and I told them that I have other options. I said that I will take my business elsewhere if they didn’t rescind their decision. The customer service rep asked me a few questions like my occupation, current employer, length at current employer, my salary and how much I had in cash savings. After talking with his supervisor, he got back on the phone and told me they would rescind their decision.
Now, in my situation, I could have done nothing. The fact that they lowered my credit limit would not have affected my credit score. But since I knew we were going to cover this topic, I wanted to see what my card company would do if I called them and complained. So you must push back.
But you need leverage and that means having a good FICO score of 720 or higher. Many banks want to keep good customers who are low risk and unlikely to default, and those are customers with excellent credit.
You mentioned credit score, what is a credit score?
A credit score is just a number generated at a particular point in time. And creditors use this number to assess the likelihood that you will pay them back. It also can affect your auto insurance premium as well as your ability to get a job. Remember, credit is the ability to use someone else’s money. So your credit score is very important in your financial life.
The most well-known provider is Fair Isaac Company or FICO for short. FICO started in the 1950s and about 90% of all creditors use this score and about 75% of all mortgage lenders use this score. The range is from 300 to 850. Anything over 750 is excellent and anything under 620 is risky. The average American has a credit score of around 675.
Can you give us some tips on how to boost a credit score?
To boost your credit score, the first thing you will want to do is pull your credit report. You can pull your credit report for free by going to annualcreditreport.com. The three major credit bureaus are Experian, Equifax and Transunion.
Once you get your credit report, look through it for serious errors. A serous error is not a slight misspelling of your name; a serious error is like an account that isn’t yours or a negative mark like a late payment or default. Unless the negative mark was a bankruptcy, it should drop off after 7 years.
If you find serious mistakes, go ahead and dispute them. Sometimes this process is very easy and the negative marks are taken off. Other times, it’s more difficult. In that case, you will have to dispute it directly with the lender. If that gets you nowhere, it may be best to hire an attorney. Paying an attorney a couple hundred dollars to clear your credit report could literally save you thousands of dollars in extra interest because of the mistake.
Next you’ll want to see how you are using your credit cards. This determines your credit score. Thirty-five percent of your credit score is based on your payment history. So always pay your bills on time. You’ll also want to keep your balances low. The closer to being maxed out you are, the lower your score. Thirty percent of your credit score is based on your utilization rate. We talked about this earlier. You really need to keep in mind that credit bureaus do not distinguish between the balances you carry every month and the balances you pay off every month. If you max out your credit card every month but pay it off every month, you still are using 100% of your limit and that will negatively impact your score. If you can, get credit utilization rate down below 10%. That does the maximum good for your credit score.
Getting back to rate and fee increases, why are credit card companies doing this?
Many card companies have been losing money, and they’ve been making up for it by increasing rates and fees and reducing credit lines. They also are trying to make as much money now before the new Federal Reserve regulations regarding deceptive credit card practices go into effect July 2010.
What are a few of those new rules?
The big one of course is that credit card companies won’t be able to arbitrarily increase your rate, unless there is a concrete reason to do so. The other is statements would have to be mailed to you at least 21 days before payment is due rather than the current 14-day minimum. That rule is designed to make it less likely that credit card companies can catch cardholders off-guard by moving up a due date so the cardholder ends up making a late payment. Late payment fees average $39 a pop. There are other rules as well. But the bottom line is the new rules are designed to protect the consumer.
As a financial planner, though, I would like to make a general comment on the use of credit cards. While these regulations and others will go a long way to end some of the deceptive practices credit card companies’ employ, many of the problems resulting from these practices can be avoided by simply using credit wisely or not using it at all.
Credit card debt in this country has jumped 25 percent in the past 10 years, reaching almost $1 trillion, according to the Federal Reserve. We have been living on the financial edge far too long and its time consumers also bear some of the responsibility.
Credit card companies are in business to make money. They are not your friends. So, as a financial planner, I would be remiss if I did not urge everyone listening to first of all please make sound choices with your credit and please do your best to live within your means.
The Senate this past week voted on the Credit Cardholders’ Bill of Rights Act 2009. What is in there to protect consumers?
This is what I like about the bill:
• Bans issuing cards to anyone under 18
• Bans fees for customers who pay over the phone
• Bans retroactive interest rate increases except in certain cases
• Requires that customers be notified of rate increases 45 days in advance
What if anyone listening is swimming in credit card debt and needs help. What can they do?
I would recommend calling the National Foundation for Credit Counseling, also known as Consumer Credit Counseling Services. This is the nations largest and longest serving nonprofit credit counseling network. Visit their website at www.nfcc.org to learn more.