Card Issuers Get Drastic on Plastic

Credit-card issuers are pulling off some almost-magical feats these days. They're conjuring higher interest rates (despite multiple rate cuts by the Federal Reserve), shrinking credit limits in the blink of an eye and, even transforming themselves into bank holding companies (as in the case of American Express (AXP)).

While many of these exploits aren’t exactly new, they're being carried out at a much faster pace, says Jose Garcia, associate director for research and policy at Demos, a New York-based economic research and advocacy group. The reason: Issuers are panicking over cutbacks in consumer spending and rising cardholder default rates. “We’re looking at an industry that is desperate to make back the money it’s losing,” he says. In August, banks wrote off 6.8% of credit-card balances -- more than $1 billion during the third quarter -- as unpaid, a 48% increase from the previous year, according to Moody’s Investors Service.

Unfortunately for consumers, the credit-card industry is loosely regulated. Read the fine print of a cardholder agreement and you'll soon discover that issuers reserve the right to make unfavorable changes to account terms at any time. “Consumers have to understand that a promise from a credit-card company is not a promise at all,” says Ed Mierzwinski, consumer program director for the U.S. Public Interest Research Group, a consumer advocate. “They can do what they want, whenever they want.”

The answer for cardholders is constant vigilance. Here’s what to watch out for in the coming months:

Anyone applying for a new credit card these days is going to need a stellar credit score of at least 700 (if not higher) on FICO’s 300- to 850-point scale, says Scott Bilker, founder of money management site DebtSmart.com. (Precrunch, even a 600 would do.) That means maintaining low balances, paying on time and not doing anything that can wreck your score. Those with a poor score, on the other hand, better start fixing their credit. (Read our story for tips on how to do so).

A bad credit score isn’t the only thing that can lead to less favorable cardholder terms, warns Mierzwinski. Issuers are also dusting off so-called behavioral scores, which compare your shopping habits -- what you buy and where you buy it -- with those of consumers who defaulted. Card issuers don't disclose what specific behaviors are considered risky, however, so the best defense is to pay on time and maintain a low balance, he says.

It’s in the fine print -- most major issuers can change your interest rates, for any reason. That includes padding profits to ease their own financial woes, as well as punishment for perceived bad behavior on the cardholder's part -- either with them or other lenders, says Mierzwinski. Citibank (C) announced Friday it would increase some cardholders’ rates by an average of 3% due to its financial troubles.

The Federal Reserve and Congress have made credit-card reform a top priority. The crackdown on creditors doesn’t bode well for consumers looking for promotional offers, which are already drying up, says Bilker. American Express, for example, ditched its 4.99% for life offer in September for a promotion extending 2.99% for 12 months. “The best offers are on the cards you already have,” he says. If you don’t want to open a new card and lock in a rate, keep your current cards in good standing to attract offers.

Issuers are slashing credit limits left and right, says Curtis Arnold, founder of credit card information site CardRatings.com. According to the Federal Reserve’s October survey, 20% of issuers lowered limits for prime borrowers (those with stellar credit scores), while 60% cut those of less credit-worthy borrowers. Lowering a credit limit increases the risk of a cardholder overcharging, which can result in nasty fees, a higher interest rate and weigh on their credit score. To protect yourself from going over a recently-reduced limit, check your available balance before making any large purchases.

Big credit lines aren’t the only untapped credit catching issuers’ eye. Many card issuers are closing accounts that haven’t been used in the past year, says Arnold. That reduced credit availability can hurt your score, more so if you’re losing an account with years of good history. Entice issuers to keep old accounts open by using them at least once every six months.

Expect fewer opportunities to earn points from your rewards card. Chase (JPM) recently reduced the rewards on its popular Chase Freedom card to just one point per dollar spent on all purchases (it used to offer triple points on purchases in a cardholder's top three spending categories). Even introductory offers have more strings attached. “It used to be getting the card got you points,” says Arnold. “Now it’s, get the card, spend $750 and then we’ll give you the points.” Look for a cash-back card, where any changes to your rewards-earning potential will be obvious, he says.

Industry upheaval isn’t all bad for consumers. Here are two good things to come out of the credit crisis:

Generous holiday promotions
Retailers aren’t the only businesses scared by dismal holiday sales predictions, says Bilker. Issuers depend heavily on shoppers using their credit cards so they can collect merchant fees with each purchase. Expect very aggressive promotions, including bonus rewards and exclusive coupons, on both regular and store credit cards, this holiday season. MasterCard (MA), for example, offers a coupon for $225 off a purchase of $900 or more at watch retailer Tourneau, good through Dec. 31.

Room to negotiate
The Financial Services Roundtable, which represents more than 100 large banks and brokerages, recently joined consumer advocacy groups in developing a plan to let lenders forgive up to 40% of struggling consumers’ credit-card debt. The aim: Stem the losses from borrowers defaulting on their entire balance. Although federal bank regulators rejected the plan Wednesday, banks’ participation indicates they are willing to waive fees, reinstate lower interest rates and work out repayment plans, says Arnold. “They’d rather collect 50 cents on the dollar than nothing when you file for bankruptcy,” he says.