When Cheryl Reed noticed the interest rate on her Bank of America statement had jumped from 4% to 28%, she immediately called the company.
Reed questioned the representative about the change, and she was told she’d done nothing wrong. Rather, the company was increasing its rates across the board.
Reed was not consoled. She routinely paid off her cards, had sizeable limits and maintained credit so healthy she averaged low rates for years as a longtime customer in good standing.
“I was totally incensed and told them we’d pay it off and stop using it,” she says. “We now use American Express.”
Believe it or not, Reed’s response is exactly what credit card companies are banking on.
LSU Finance Professor R. Kelley Pace says many cardholders are feeling the sting—including those who pay on time and especially those in economically hard-hit areas.
Why? Because companies such as Bank of America, JPMorgan Chase and Citibank—the industry’s biggest card issuers—have not only aggressively reduced risk exposure based on credit scores but also on ZIP codes, targeting areas where housing values are falling.
Even though the Capital Region has remained comparatively stable, cardholders have been affected by tougher credit adjustments. Those customers with high risk are paying more interest and helping defray company losses—which are rising—while those customers who pay off the card simply put it away.
Customers who default on their debt also face laws the credit card companies helped reform in 2005, which has made it more costly to declare bankruptcy. People with higher income typically have to declare Chapter 11—as opposed to Chapter 7—putting them on a payment plan that ensures their credit-card debt is paid, which is why losses have been higher in other lines of credit.
“It’s not going to be good for the economy, but it’s better for their business,” Pace says. “They’re not charged with helping the country overall. They’re managing their credit.”
Bank of America spokeswoman Betty Riess says less than 10% of the company’s U.S. customers [the company will not clarify how many of its 70 million customers worldwide are in the U.S.] have been affected this year. The company recently notified a “small portion of customers” with an APR below 10% of a rate change that takes effect in June.
Riess says the increase, averaging in the low- to mid-teens depending on the account, is aimed at covering the significantly higher cost of providing credit. The majority of Bank of America customers, she says, have not seen an increase.
JPMorgan Chase spokesman Paul Hardwick says his company lowered accounts to counter higher risk in the downturn, but there have been no across-the-board reductions. Customers were given a 45-day notice in writing of interest hikes.
Also, Chase Card CEO Gordon Smith recently announced the company increased credit lines by $107 billion while it decreased or closed accounts totaling $129 billion to stem risk.
With 401[k] retirement funds down one-third or more, higher unemployment and an intensifying economic downturn, all consumers are more risky today than last year, says Peter Garuccio, a spokesman for the American Bankers Association. Credit cards are unsecured debt based on a customer’s promise to repay.
“A mere promise to repay doesn’t carry the same strength as it did before,” he says. “The single biggest indicator of a customer’s ability to repay their loans is whether they have a job. We all understand the economy is in a significant downturn and unemployment is on the rise. Card issuers are reacting to those broader economic forces and taking necessary economic steps to minimize their exposure to risk.”
Credit card companies apparently can’t get affordable credit, either. Garuccio says higher interest rates also are aimed at protecting their profit margin, on average 3%. Issuers are also dealing with tighter and higher cost credit in the secondary market, where nearly half of their loans are funded. While not widely known, he says credit card loans are backed by asset-backed paper, which is a relatively dry market now.
According to a 2006 report by the U.S. Government Accountability Office, credit card companies’ main source of revenue—70%—is interest. It has been this way for more than 20 years.
With the industry so reliant on interest for its income, Garuccio maintains it’s in everyone’s best interest to work out credit problems.
“Everyone competes for the same wallet, so they’re taking proactive steps to help people find a way to meet their obligations,” he says. An industry collaborative effort, Helpwithmycredit.org, has been established to educate consumers on available assistance such as working with a lender or a debt counselor.
Instead of looking to a Web site for help, millions of customers appealed to Washington.
The Obama administration recently announced it would push a credit card law to eliminate tricky fine print, sudden rate increases and late fees. The House and Senate are considering bills to strengthen consumer protections. The nation’s supermarkets and their wholesalers, also maintaining Visa and MasterCard are gouging them on interchange fees—about 2% on every card transaction—also have asked for help.
To ease public outcry over being credit crunched, the Federal Reserve Board adopted sweeping reforms in December to level the playing field between credit card companies and consumers.
Until this year, Americans heavily used credit cards to subsidize their cost of living. Rate hikes—some as high as 26%—mounting late fees and withdrawn lines of credit sent them thundering to Congress with complaints of predatory lending. The average household has two credit cards and averages $7,000 of card debt a month.
An unintended consequence of these rules, combined with the recession, could mean more than $2 trillion less available credit in the marketplace. And effective July 2010, cardholders should gain more notice, disclosure and control of rates and fees.
But Emma Dixon, president and CEO of the Louisiana Community Reinvestment Coalition, wants more anti-predatory laws on the state level.
Some states have introduced legislation to stem predatory lending. Dixon advocates measures such as the setting of interest-rate caps, as well as counseling and financial literacy to help people use credit more responsibly. Until then, she says many people have to learn to live within their means.
“Think about a single mother with the card and higher fees and rates that can affect her ability to pay,” she says. “That will affect her long-term credit history. This is just as much an issue in Louisiana as anywhere.”
LSU’s Pace says the reality is it’s a credit crunch for many people who need credit. He recently received an interest hike on a credit card he wasn’t using and isn’t planning to use.
“They are paying attention,” he says. “That was a way of saying to me, ‘We’d appreciate it if you don’t use the account, but if you do, we know you do have some problems.’”
