Credit-Card Issuers: Buy Something or Else!

One of the biggest causes of the financial crisis was that Americans were borrowing (and spending) more money than they could afford to pay back.

So how are credit-card issuers reacting to consumers’ attempts to live a more financially responsible lifestyle? They’re threatening to cut their credit cards off if they don't spend enough.

Loretta Maxwell of Troy, Mich., thought her credit score of 790 buffered her against most of the fallout of the credit crunch. When Chase (JPM) closed her $6,000-limit card in December without warning after two years of inactivity, she called to fight it. She was unsuccessful. “If you’re not using it, they entice you to do so, and then the moment you don’t spend enough, they cut your limit,” she says. (Chase says it is standard practice is to review inactive accounts. “Inactive cards with large open credit lines present a real risk of fraudulent use and large potential liabilities for Chase,” says spokeswoman Stephanie Jacobson.)

Maxwell’s experience is far from an isolated incident. Most major issuers, including Chase, Bank of America (BAC), American Express (AXP) and Citibank (C) have been slashing credit lines and closing the accounts of those who don’t spend on their card regularly. While these issuers are required to notify you in writing of an account closing, there’s no requirement that they do so in advance. Even when they do give early notice, the only way a cardholder can stop their account from getting shut down is to start spending again.

In December, Discover (DFS) reported that it closed three million accounts during 2008 due to inactivity, and plans to cull up to two million more. A Discover spokeswoman says the issuer is constantly reevaluating cardholder’s credit and assessing whether they have the most appropriate credit line and product.  Capital One (COF) is suspending accounts that have been inactive for at least a year, warning account holders they only have 60 days to redeem their rewards. “Some of these accounts had literally never been used,” says spokeswoman Pamela Girardo. A spokeswoman for Bank of America, meanwhile, says the bad economy prompted it to close accounts with zero balances that have been inactive for more than a year. American Express spokeswoman Lisa Gonzalez says it periodically reviews inactive accounts for cancellation. Citibank did not respond to requests for comment.

From a business perspective, cutting off certain customers is a smart financial move, says Sanjay Sakhrani, an analyst with investment bank Keefe, Bruyette & Woods. Closing rarely-used accounts lowers a card issuer's risk profile by keeping their potential liabilities (i.e., the amount of credit available they extend to cardholders) from outweighing their assets. Inactive accounts also cost the issuer money to maintain, without providing the benefit of income from interest or merchant fees, he says.

For consumers, however, account closings can be devastating -- especially to their credit score. Your credit utilization ratio – the amount of your debt in relation to the amount of your available credit -- comprises 30% of your score, says Craig Watts, a spokesman for Fair Isaac Corporation (FIC), the company that calculates and issues the FICO credit score that most lenders use. So when an account is closed, you have less credit available to you -- and the ratio immediately jumps higher. A person with a solid credit score of 720 or so, whose utilization ratio jumps from 35% to 75% after one of their accounts is closed is likely see their score drop by “several dozen points,” to somewhere in the 600s, he says. That’s a far cry from the 760 (or higher) consumers need to get the best rates from lenders.

One thing that somewhat softens the blow is that FICO factors in closed accounts when calculating the longevity of your credit history, which accounts for 15% of your score. While lenders may make a note on your report indicating whether the account was closed by them or you, the information isn’t used in the scoring formula, says Watts.

Ironically, an excellent credit score can actually serve as more of a bulls-eye than a shield, says Dennis Moroney, a research director and senior analyst for consulting firm Tower Group. He says banks figure they can limit cardholder backlash by targeting consumers with few debts and plenty of other accounts. That way, a closed account won't have as much of a detrimental effect on their creditworthiness.

Even years of loyalty and regular spending won't spare some cardholders. David Good of Houston, used to be devoted to American Express, with which he had two credit cards: an unlimited charge account and a $7,500 revolving account. Yet a solid credit score, eight years of on-time payments and fairly frequent purchases on the cards -- including more than $100,000 last year alone -- weren’t enough to save his accounts. In December, Good received a written notice that the issuer had closed both due to “low activity in the past six months.” “I was shocked,” he says. “They lost my trust, totally.” (American Express declined to comment on Good's or any other individual's accounts.)

New Yorker Veronica Eady Famira was vacationing in Germany when she discovered that her $1,500-limit Delta (DAL) SkyMiles card from American Express had been shut down. “I must have spent $300 in cellphone charges calling banks,” she says. “I was pretty stranded.” Adding insult to injury, Famira had just earned a free companion ticket on the card valued at up to $400 for a domestic flight – now she can't redeem the ticket.