The Credit Crunch Hits Home
Credit-card companies are reducing limits and removing customers to get risk off their books.
There are plenty of economic factors to consider during a job search, especially during a down economy: Housing prices have slumped, and 401(k)s and other investments are in decline.
Now add the global market for credit cards to the list of factors you must watch if you’re looking for a job.
Credit cards and access to credit can be crucial to bridge the gap in living expenses during a stretch of unemployment and pay for the expenses of a job search, like membership to a job board or a new suit for a third interview. But that lifeline is being shortened by factors outside the control of the people who rely on them. The global crunch on corporate credit, rising unemployment and risk-averse banks are conspiring to make credit cards costly and less available. Nationwide, credit-card providers are raising interest rates, lowering credit limits, and closing accounts for card holders who did little or nothing wrong.
More than 30 million U.S. card holders (16 percent of total card holders) saw their credit-card limits reduced in 2008, according to Fair Isaac Corp., which manages the FICO credit-score program. Twenty-two million of those affected never had a late payment, collections or other issues that would ordinarily have triggered a penalty. Most were card holders who barely used their cards or carried low balances that were unprofitable for the card provider, several credit experts said.
What is happening to cause credit-card companies to cut good customers just when they need the help most?
There are ways to better the odds you won’t be in this group. Download Ladders’ exclusive PDF checklist “How to Conserve Credit for a Job Search” for a step-by-step guide to staying on the right side of the credit-limit squeeze.
Meanwhile, want to understand the pinch better? There are three global forces at work to crank up the pressure on your credit:
Banks are not the only companies looking for ways to get rid of shaky debts, according to Steve Conover, founder and CEO of MyCreditABC.com, which specializes in helping customers check and resolve mistakes in their credit-bureau reports.
Poisonous assets on the books at a bank might comprise a bundle of home loans, but bad debts on the books at a credit-card company compromise the many individual consumers who are having difficulty making ends meet.
“Credit-card companies are changing how they evaluate risk on a monthly basis,” Conover said. “They have a serious issue with the cash they have on hand and the Treasury rules on default, so they have to reduce their risk. Risk in this case is the credit-card customer, and they’re cutting a lot of them off; it’s getting really ugly.”
Just as with banks, which went on a mortgage-lending spree during the early 2000s on the assumption they could bundle their loans into packages that would effectively reduce their risk, credit-card companies expanded rapidly both the number of customers and the amount of credit they’ve granted.
That’s not a problem when the economy is strong and people can keep making payments; when it’s less than strong, the number of people defaulting rises. In the typical recessions in the past 50 years, the number of accounts the industry considered uncollectable (called a “charge-off”) rose to between 3 percent and 5 percent. In January, that rate struck 8.82 percent, the highest mark in more than 20 years, according to Moody’s Investors Services. CitiGroup and Capital One Financial, two of the leading issuers of MasterCard and Visa cards nationwide, announced that 9.33 percent of cardholders were in default for February and March respectively and American Express, which professes a more financially secure membership base, has a rate reaching 8.7 percent in March. Moody’s expects the charge-off rate to ultimately reach 10.5 percent.
This rapid rise in cardholders unable to repay their debt causes card issuers to do two things:
- First, banks limit their exposure by dropping card holders they consider close to risky and lower the limits on those next in line;
- Second, banks make up some of their losses with higher interest rates and fees. Capital One raised a rate on one card from 7.15 percent to 11.9 percent and another from 8.15 percent to 13.9 percent, according to The Motley Fool columnist Selena Maranjian. Citigroup raised its top rate to 30 percent, while Capital One instituted a penalty rate of 29.4 percent for customers who are late paying their bill two months in a year.
“It’s getting pretty brutal out there in terms of contraction and delinquencies and interest-rate increases,” according to Curtis Arnold, CEO of CreditRatings.com, a credit-card rating and review site. “We’re seeing millions of accounts closed off that haven’t been used in a while, and even people who have not been carrying substantial debt or being near their credit limit aren’t immune to having their interest rates raised.”
“People aren’t even aware of this, but the credit-card companies are getting really aggressive about getting people they identify as high risk off their books,” Arnold said. “If you always pay just the minimum, that will flag you as high risk.”
Worse, they can identify you as a bad risk and lower your credit limit below the amount you currently owe, demand that you pay the difference immediately, and then write you off as a bad debt if you don’t respond, MyCreditABC.com’s Conover said.
Mortgage companies are more willing to work with consumers because there’s a significant asset involved – the house or condo. “Credit-card companies don’t care,” Conover said. “Credit cards are unsecured, so they’ll just cut you off.”
2. Tight Credit
Even in good times, credit-card companies themselves rely on credit to pay the bills. Card issuers are able to pay for your purchases and absorb your debt because they draw on corporate credit for 10- and 30-day loans from investment banks that put cash in their coffers to pay the bills and to maintain a cash-to-exposure balance (cash on hand versus the total debt exposure should every card holder reach his maximum debt limit). When investment banks began to collapse and bleed money last year, the source of those loans dried up, and credit-card companies were deprived of the source of cash to cover expenses and maintain the cash-to-exposure ratio.
Banks faced the prospect of operating under a less-than-preferable cash-to-exposure ratio just as many card holders were most likely to achieve maximum debt load and others were defaulting at record rates. According to Conover, the response of most credit-card companies has been to limit their exposure by reducing the maximum debt load on their books – closing accounts and reducing cardholders’ credit limits. This is especially true for risky card holders or cardholders they consider unprofitable.
“If you pay the whole card off and then don’t use it for a month, they identify that as high risk, too,” Conover said. “That’s risk they carry on their books that they’re not making money off of, so they’ll cut you off in a second.”
Besides the tight economy, the push is motivated by tighter Federal Reserve rules on how much cash a credit-card company has to have on hand and limits on changes it can make to credit rates and agreements. Although the rules have already been approved, they don’t go into effect until July 2010. Until then, count on the credit-card companies to do everything they can to strip what they define as deadwood from their debt records.
Credit-card companies are also racing to get ahead of consumer protections passed by Congress April 22 that also take effect in July 2010. The rules would limit increases on credit-card interest rates and fees and address how providers communicate to customers when they make changes to a cardholder’s credit limit.
It would also ban a practice called “universal default,” whereby banks raise users’ rates or lower their limits because of late payments to completely different creditors. The new rules mean credit-card providers can only adjust your account based on your payment history with that account.
With those rules looming, card providers are trying to drop potential problem customers and limit their credit exposure on others before the law limits what their ability to do so, Conover said.