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LIMIT REDUCTIONS ON CREDIT CARDS/ OPENING & CLOSING
CREDIT
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I have written an article on
this topic before but it seems to be confusing and shocking to
consumers and professionals alike. It was over a year ago when
we started to hear about American Express reducing limits or
shutting down credit cards on consumers. American Express was
the first creditor to take an aggressive stance on protecting
themselves from credit card defaults at the consumers
expense. I remember having a client who owned a business
and used his American Express card to juggle expenses while
waiting for receivables to arrive. He was trying to take
out financing on a $1,000,000.00 + piece of property that he
owned outright. He needed 20 points on his score and had
a high balance on his card. Paying his American
Express balance down to $20,000.00, which was 30% of his limit,
was the quickest way to reach his goal. The day after he paid
the balance down American Express reduced the limit to
$20,000.00 and we were all surprised and obviously very upset since
his score dropped 70 points. This took him further away from
his goal.
It is important to understand the creditor's are looking for ways to
reduce their risk factor on future defaults. Even if a consumer
has NO late payments or negative information on the credit profile,
if they carry balances over 50% of the limits this is a red flag for
the creditor that the potential to default is there. If
you have $50,000.00 of debt and your limits are $80,000.00 you can
see how a creditor would be thinking of the potential risk in a bad
economy. Most creditors wait until balances have been
reduced to cut the limit. They are afraid to cut limits when
there is a high balance since the credit card holder has a
greater incentive to stop paying completely. There are
those creditors who reduce the limit or even close the account when
the balances are high. This can be devastating to the credit
score. First just by closing the account the score can drop 60
points. Second by reducing the limit to less than the balance
the score will plummet. When balances are over the limit
(even if the balance is $1.00 over) it is a red flag to the scoring
systems that this consumer is a high risk and the score is driven
down dramatically.
Credit Card Companies are preparing for the February 2010 rule changes
that will force them to charge less interest to consumers and wait
longer to increase interest rates on those with late payments.
Creditors negotiated to have a period of time to prepare for
these changes and have used that time to hike up interest rates on
existing card holders before they were no longer allowed.
Many have received letters from creditors giving an option to
"Opt Out" and continue paying the current rate on the open
balance. This means the card will be closed as soon as the consumer
opts out. If the consumer accepts the new higher interest rate
the card will continue to stay active. This is putting the
consumer in between a rock and a hard place. If the card is
closed it will hurt the credit score but if the interest is raised
the cost could be significant depending on the current balance.
In this situation I would pay off the balance (if possible) and keep
the card active just to help my credit score. You can always
charge a small amount of money once a year and pay it off just to
keep the card from closing. The card should not be closed
just because you are mad the creditor is giving you this
ultimatum. Think of your credit health first (the creditor is)
unless you are having financial difficulty. For those who are
having problems making minimum payments on open balances please see
my article about "Bankruptcy, Debt Negotiation, and other
choices" from November 2nd in the Newsletter section of our
website.
We are hearing the frustration many have from seeing their credit
limits reduced and credit cards closed with no history of defaults or
late payment. Consumers feel that they are being punished for
no reason. It is important to keep balances low if you want to
protect your limits from decreasing. My opinion is to have no
more than 30% of balance to limit ratio.
When it comes to opening and closing accounts consumers have a
difficult time taking in the fact that this could cause significant
decreases in the credit scores. It does not matter if the
consumer or the credit grantor closes the account. The affects of
closing credit are negative no matter how it is closed. The
higher your score the more it drops when this occurs. The most
we have seen the score drop from closing or opening an account is 60
points. If many accounts are closed and opened around the same
time the score will drop more but not the full 60 points for each
event. The score drop can remain for up to a year. If the
consumer has little variety of credit the drop can last much longer
(see article in Newsletter section of our website about "Your
Portfolio of Credit"). Credit is considered
"seasoned" after it has over 2 years of history.
Statistics show that when consumers open and close credit the risk of
default increases. This is why the score drops when these
events occur. Make sure you time the opening and closing of
credit with the events in your life that make sense. if you are
not going for financing for a year or two that could be a good time
to open more credit and build your credit portfolio or close accounts
you no longer want.
"Great credit brings
great opportunity!!"
Copyright © 2009 North Shore
Advisory, Inc.
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Tracy A. Becker
President
155 White Plains Road
Suite 203
Tarrytown, NY 10591
(914) 524-8300
(914) 524-5014
www.northshoreadvisory.com
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