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Every credit card account should come with a prominent warning label: “Danger: Your credit limit is bogus. Ignore it. When your charges exceed 40 to 50 percent of your credit limit your credit rating begins to diminish. Hit your limit and watch your credit scores nosedive 100 points or more.”
Of course, no such warning exists, and that’s the problem. There isn’t even a hint that a credit limit is simply an enticement, which — if succumbed to — will destroy your credit ratings.
On Tuesday, this problem received nationwide attention. A mother and homemaker from Michigan found herself in the spotlight when she testified before the Senate Banking Committee on the financial damage she incurred at the hands of her lender. Janet Hard never exceeded her credit limit and always made more than the minimum payment on her credit card bill, but her credit scores dropped anyway. This caused Discover to nearly triple her interest rate to 24 percent without informing her.
The result? In the last two years, Hard paid Discover a total of $5,618, but 62 percent of that, a whopping $3,478, was accrued interest. During the last year, she paid $2,400 to Discover, but only reduced her debt by about $350.
“My husband and I feel as though we have been robbed,” Hard told the panel.
As troublesome as Hard’s story is, something even more disturbing happened that day. No one at the hearing, or in follow-up commentary, addressed why her credit scores declined. The bankers who testified before the Senate did not explain that Mrs. Hard’s credit scores dropped because she used the full limit on her account and kept a high balance for several months. No one mentioned that credit card information which accompanies each card often states — in small print — that the creditor has the right to raise your interest rate if your credit scores drop and/or you make a late payment on a different account.
Senator Carl Levin, chairman of the Senate Banking Committee, has stated that borrowers who conform to all requirements for a specific account should not have the interest raised on that account due to circumstances unrelated to it. The Banking Committee is threatening legislation. Bankers are pushing back, saying they must assess the ongoing creditworthiness of borrowers to protect their financial institutions from risk.
Situations similar to Mrs. Hard’s happen to millions of people every year. If you believe keeping your balance below the credit limit and paying your bills on time will produce excellent credit, nothing could be further from the truth.
Learn from Mrs. Hard’s mistakes. Yes, it is essential to pay all bills on time, but to raise credit scores you must keep your balance on every credit card account below 30 percent of the credit limit. To drive scores up rapidly, charges need to remain below 10 percent of the credit limit on each account.
If there is a reason you must charge more than 40 to 50 percent of the limit on an account, get the balance back down to under 30 percent of the limit as quickly as possible. You are much better off keeping every account balance below 30 percent than having some at zero and some higher than 40 to 50 percent of their limits.
For the first time in several years, lending practices and banking policies are being examined and subjected to congressional oversight. While lenders deserve to profit from providing credit to consumers, secret or unknown lending practices — not clearly explained to borrowers — smack of dishonesty.
Check your credit card statements every month. If you see an increase in your interest rate, call the creditor to find out why. If they say your credit scores dropped, ask them to send you a copy of the credit report they used to make their decision. When you receive the report, check it to be certain your bills are driving your scores down. If you find inaccuracies, use the information in my column, How to Correct Mistakes on Your Credit Report, to make corrections.
If you review your credit reports and you cannot find a cause for the increase in your interest rate, call the credit card company back. Ask for a detailed explanation. At the time of this writing, banks can raise your interest rate on a credit card account without cause. However, there usually is a reason. In my column, How to Survive the New Credit Crunch, I suggest steps you can take when your credit card interest rates rise.
Five major financial institutions — Bank of America, Capital One, Citigroup, Discover, and JP Morgan Chase — issue 80 percent of credit cards in the U.S. These five banks, and others, have posted significant losses because of their adjustable rate mortgage lending practices. Now they appear to be instituting credit card lending policies to limit future financial losses. Accounts are more difficult to qualify for and interest rates have increased for many customers.
The current credit crunch will last into the foreseeable future. To ensure access to borrowed capital you must adopt credit card habits that create and maintain high credit scores.