77 Percent Chance Your Credit Card Rate May Change for Any Reason

Imagine if after a year of owning your car and paying down your loan, the car dealer told you that your interest rate on the car loan was going up by double-digits because the dealer was having a bad year. Outrageous! you think. He can't do that!

Yet that is exactly what credit card issuers are doing. A survey released by Consumer Action, a nonprofit education and advocacy organization, found that 77 percent of the major financial institutions they contacted said they reserve the right to increase a cardholder's interest rates - even on existing balances - at any time and for any reason.

The reasons cited by bank officials included "the economy," "business strategies," or "market conditions" (the stated cause of recent rate hikes by Bank of America and Capital One).

At a time when a number of banks are finding themselves too heavily invested in failing mortgages, it is all too clear that some of the shortfall in profits may be covered by bumping rates and fees for consumers like you and me.

Other items of note:

• The average default rate is now 26.87 perent, up from 24.51 percent in 2007. The highest default rate in the survey was HSBC, with a default rate at 31.99 percent. Default rates can click in for a number of reasons, including late payments to another company, too many inquiries on your credit file, or even a small drop in your credit score. Once your rate adjusts to the default rate, it's very difficult to re-adjust it downward.

• "Chasing balances" is becoming a common practice whereby banks reduce credit limits based on their assessment of a customer's risk. A reduced credit limit negatively impacts your credit score by increasing your debt utilization ratio, which may then trigger the universal default clause. And if the consumer isn't aware that the limit has been decreased, he or she may very well be hit with an over-the-limit fee and then a penalty interest rate for being over the limit.

If you're not outraged, you're not paying attention. Contact your House and Senate representatives and tell them to support the Credit Cardholders Bill of Rights in the House (H.R. 5244), and the credit card bill in the Senate Banking Committee.

So What IS the Average Credit Score, Really?

I was reading an article today posted by BusinessWeek called "Buying a Franchise with Bad Credit." One of the first things that struck me was the reference to average credit scores. A nonprofit contractor for the SBA microloan program says,

"Usually they have what I'd call an average credit score—in the mid 500s or 600s—but not a high credit score."

But hold on a minute! The credit bureaus say that the average credit score in the U.S. is 692. (In case you didn't know, FICO scores range from 300-850, although other credit bureaus use different scales.) In fact, Fair Isaac says on their Web site (myfico.com):

"About 40% of credit card holders carry a balance of less than $1,000. About 15% are far less conservative in their use of credit cards and have total card balances in excess of $10,000. When we look at the total of all credit obligations combined (except mortgage loans), 48% of consumers carry less than $5,000 of debt. This includes all credit cards, lines of credit, and loans-everything but mortgages. Nearly 37% carry more than $10,000 of non-mortgage-related debt as reported to the credit bureaus. " They report that 58% of consumers have a credit score of 700 or more.

Yet the data from Federal Reserve says something very different:

"The average household has $11,000 to $12,000 in credit card debt... Those figures are diluted by those who don't hold any debt. Households that carry debt from month to month carry close to $17,000 of unsecured debt on average. One out of every five households is either behind on payments or over the limit on at least one account."

To make matters worse, not only is the rate of foreclosures at an all-time high, but it is projected that 10% of home owners (approximately 8.8 million people) will have negative equity by month's end.

Hmm. According to the bureaus, 30% of your score is determined by your debt ratio: how much money you owe, divided by the amount of available credit you have. Thirty-five percent of your score is based on payment history. In total, that's 65% of your score - and the data shows that the majority of American households are not doing so well in these two areas.

Now factor in the sneaky credit industry tricks -- universal default (where credit card issuers can raise your interest rates should your credit falter - even if you have never made a late payment), interest rate increases for no reason, not reporting your true credit limit on cards, "chasing balances" (where credit card companies reduce your credit limit as you pay down the card) -- and it's clear that the average consumer's credit score is being attacked from so many angles that an "average" credit score of nearly 700 is improbable.

Ask any residential mortgage broker or loan officer if their average applicant's credit score is 692. Just be prepared for the snickers or guffaws.

My business partner was speaking with a mother of three the other day. As she was talking about her credit, her demeanor completely changed - her shoulders slumped forward, head hung low, voice full of apology. She truly believed that she "deserved" to pay higher interest rates because of her "poor credit." Yet if she knew that the majority of people had credit scores in the same range as hers, would she be so accepting?

AmEx Artificially Deflates Credit Scores

As you may recall from previous posts, 30% of your credit score is based on your debt ratio. The Big Three credit reporting agencies – that's Experian, TransUnion, and Equifax - use special software to calculate this ratio.

We've already discussed the Sneaky Credit Industry Trick where some credit card companies do not report the actual credit limit, which causes the software to use the highest reported balance as the "credit limit," biasing debt utilization calculations against the consumer. This was one way to artificially deflate their customers' credit scores, making them unattractive to their competitors.

According to SmartMoney, American Express is among a number of credit card companies that are now employing another Sneaky Credit Industry Trick: chasing balances. Consumers are reporting that as they pay down their credit card balances, the credit card company is penalizing them by lowering their available credit limit.

They tell the story of Trent Charlton, who paid off more than $8,000 in credit card debt in the last six months, with the goal of paying off an additional $10,000 in the coming weeks.

Six months ago, Charlton paid his American Express credit-card balance down to $14,000, AmEx decreased his limit from $20,000 to $14,300. Another payment several weeks ago brought his balance down to $10,000 — AmEx then cut his limit to $10,300. AmEx has also slashed the $2,000 limit on a card he rarely uses down to $500, barely above his $300 balance. And the limit on his GE Money Card (issued by General Electric Money Bank) where he owes $7,000, was recently cut from $15,000 to $7,500.

With an increasing number of delinquencies, credit card companies are doing everything they can to tighten lending standards and reduce the risk of default. CNN's latest statistics show the percentage of people who are late on their credit card payments is the highest it's been in three years.

Looking at the subprime crisis and weakening economy, this would be a logical rationale - except they are not targeting just high-risk customers. Lenders now are including customers that - not that long ago - would have been considered good customers, even considering factors such as where the customer lives (ie: in an area of high foreclosures) or where he or she works (mortgage companies, construction-related businesses and home builders).

Trent's credit score SHOULD have increased significantly based on his repayments. His original credit limit was $20,000. After paying the balance down to $10,000, he should have a 50% debt utilization ratio. Instead, by dropping his credit limit to $10,300, the scoring algorithm calculates his debt utilization ratio to nearly 100% - making him a "bad" candidate for credit.

The same goes for the GE Money credit line. With a credit limit of $15,000, his debt ratio SHOULD be just under 47% after paying down his balance to $7,000. Instead, by dropping his limit to $7,500, his debt ratio is over 93%.

According to Craig Watts of Fair Isaac (the company that created the FICO score), if your credit utilization is 50% or more of your credit limit, "you are doing some real damage to your credit score." And when the new FICO scoring model is released in May, "if you have a utilization of over 50%, you'll be penalized even more heavily."

Clearly, the system is flawed as it is not accurately representing the borrower's willingness or ability to pay. And with such high debt ratio calculations, other lenders will probably think twice before issuing Trent more credit - keeping him locked in with American Express and GE Money Bank until his debt is completely paid off.