Credit Card Companies... Friend or Foe?

Have you ever wondered exactly how credit card issuers stay in business? The credit card companies mail an approximate 4 billion solicitations each year. Despite the fact that they come in different colors and sizes they all have one thing in common. They are all trying to convince you to apply for one of their credit cards. Depending on what source you believe, the industry will mail between 16 and 20 times to each credit-qualified consumer in the United States. In layman’s terms this means each of us gets, on average, sixteen to twenty pieces of mail annually from credit card companies trying to convince us to apply.

The response rate of these mailings, also known as “pre-approval” mailings, is abysmal. The industry averages no more than a 0.6% response rate. And, of the 0.6% who respond, fewer will actually ever open and use the account that they’ve applied for. And, of those few who do open an account, even fewer will actually revolve a balance from one month to the next. And, of those who do revolve a balance, fewer still will actually pay their bills on time. So, again, the questions is…how do these companies stay in business?

Don’t be swayed by the pessimistic tone of the introduction. These companies make piles and piles of cash from their credit card portfolios. So, please put away your checkbooks and stop thinking of sending your charitable contribution to Delaware and South Dakota, where most of the large credit card issuers are based because of favorable state laws.

The problem is that none of them have figured out what to say, how to say it or what kind of envelope to put it in to convince us to apply for their wares more than 6 times out of every thousand envelopes they mail. For every 1,000,000 pieces of mail they will get 6,000 responses. If only 80% of those responders actually open and use an account then that’s 4,800 new accounts. If each of those new accounts generates only $30 each month in interest (a very reasonable amount) then that’s $144,000 each month or $1.73 million dollars per year. Now you’re getting the picture on how these companies stay in business. And, to boot, 1,000,000 pieces of mail is nothing for the large credit card issuers who will send out several hundred million solicitations this year.

Once you are on their books as a customer the fun really begins. They love you when they are trying to get your business but you will eventually lose your luster. You are no longer the flavor of the month. You are now a living breathing profit center to them. And they’ve figured out plenty of ways to separate you from your hard earned dollar. Further, they’ve managed to self justify the means almost as to seem normal. Here are the most common ways credit card issuers will make money from you once you’ve started using their cards.

Interest

Interest is the fee you are charged for using someone else’s money. It is expressed in the form of an interest rate. This rate is applied to the balance on your credit card that you do not pay off each month. This is commonly known to as your “revolving balance.” The interest you pay is not applied to the principal balance you owe. Since your minimum payment is largely interest, paying the minimum will leave your balance relatively unchanged for years or even decades in some cases.

Your interest rate is assigned when your account is approved. If you have good credit then your interest rate should be competitive. If, however, your credit is average or poor then you should expect to pay a higher interest rate.

Some people assume that the interest rate always stays the same. This couldn’t be further from the truth. If you have a decent rate but begin to make late payments then it is very likely that your rate will increase. This is an effort by the credit card companies to “insure” themselves against customers who have become higher credit risks by missing payments.

Fees

Fees can be assessed for almost anything. If you are late then you’ll have to pay a late fee. If you charge more than your credit limit allows, you’ll have to pay an over-limit fee. Some credit card companies charge you a fee if you take out a cash advance against your account. And, the ultimate slap in the face, some credit card companies even try and charge you a fee for you to transfer balances from a competing credit card over to their card. American Express cardholders have become desensitized to the fact that they still pay a “membership” fee each year. This is quite a coup for American Express considering the fact that few other credit card companies charge membership fees.

You’d think that these creditors would be too busy to levy and collect fees that run no more than $20 or $30 each. In fact, the opposite is true. Creditors love fees, especially late fees. Industry insiders have estimated that the amount of money credit card issuers make each year from various fees is over $15 billion dollars. As you can see, it’s well worth the effort to collect them.

Sadly, there are thousands of stories about consumers who pay the minimum amount for years only to see their balances continuing to increase despite not using the card any longer. This is called reverse amortization. This is when fees and interest outpace the amount you pay each month. You can easily find examples of consumers who could have paid the credit card off several times over yet are still left with a balance. All of their years of hard work went to paying interest and fees and not the actual balance of the account.

Grace Period Adjustments

When you use your credit card you are using someone else’s money for a limited amount of time. This amount of time is called the grace period. It’s the few weeks between the purchase date and the payment due date, when your balance is assessed interest. Savvy consumers have mastered the science of waiting till the last day to make a sufficient enough payment to avoid interest. They are essentially always using someone else’s money for free. Most of them use online bill paying services to avoid the delay of mailing their payment.

The credit card issuers know this and have devised a plan to circumvent these grace period artists by taking advantage of loopholes in the law that allow for adjusting the grace period. The closer you get to the due date the more likely you are to miss a payment. If you start missing payments you can be sure that your grace period will be reduced. This is a way for the credit card companies to shorten the amount of time you can use their money for free and also pick up some late fee revenue.

Unfortunately, older or less sophisticated consumers are often the victims of these bait and switch tactics as the disclosures required before the grace period adjustment are cleverly worded and hidden amidst other text.

Credit card companies are “for profit” businesses. Don’t ever forget that. They are also highly regulated and scrutinized because of a history of consumer abuse patterns. This can be illustrated the next time you get your credit card statements or solicitations in the mail, which are loaded with mandatory disclosures, normally in very fine print. These disclosures take up an estimated 25% to 50% of the weight of the piece of mail thus adding to their postage costs. This is a fact that the credit card companies are less than thrilled about.

Abuse by credit card companies was most evident several years ago when a disturbing trend began. The credit card issuers started to omit data in their monthly reporting to the credit reporting agencies. The data, specifically credit limit information, was omitted in an effort to hide the true value of a customer from their competition. Unfortunately, the byproduct of this credit limit omission is an inaccurate credit rating or credit score.

Credit scores use sophisticated algorithms to assign points based on a consumer’s credit reports. One of the most valuable components of any credit score is the aggregate revolving credit limit of a consumer. The higher your credit limits the less likely you are to seem overly burdened with debt. For example, if I have a credit card with a $20,000 credit limit and a $1,000 balance I am only utilizing 5% of my limit. This is very good for your credit score.

Unfortunately, the credit card companies took it upon themselves to ignore the potential impact to the credit scores of some 200 million consumers by simply omitting that information from credit reports. They viewed a customer with a high credit limit as being susceptible to other more compelling offers from their competition. So they just stopped reporting credit limits.

This result of this trend, localized only to the credit card industry, was swift and brutal.
Consumer credit scores dropped by 20, 50 or 100 points or more in less than 180 days. This resulted in thousands of credit declinations and even more approvals at less than optimal terms.

Fortunately, the trend reversed itself almost as quickly with credit card companies re-reporting credit limits to avoid lawsuits and dissatisfied customers. Amazingly though, there are still companies who refuse to report an accurate credit limit on their customers.

So, Friend or Foe? A compelling argument can be made for each side of the debate.

Friend — The credit card environment in the U.S. is more inviting than any other country. The reality is that pretty much anyone can get a credit card. In other countries the protocol calls for saving your money and paying cash for your belongings. In this country as long as you have a salary and a decent credit rating you can buy a car and a home complete with furnishings all using someone else’s money.

Foe — Opponents will counter that the credit card issuers are allowed too much leeway to aggressively market. This has lead to predatory lending practices from unscrupulous lenders and an increase in amount of household credit card debt. There are also too many offers targeted specifically to new credit users, typically students, who end up entering the workforce in severe debt and close to bankruptcy.

You can also make a good argument that without a credit card you can’t function efficiently in today’s environment. This can be a pro or a con. You can’t rent a car, check out a movie, buy anything online or reserve a hotel room. You have to have a credit card to function today. It’s that simple.

The bottom line is that credit cards are what you make of them. If you let them, they can easily overwhelm you. However, if properly managed then credit cards can be your friend and ally in accumulating wealth and security…all while using someone else’s money.