For the past few months, we’ve been fortunate enough to work with a loyal group of beta users on ReadyForZero.com. Getting out of debt is not something that happens overnight, so it’s been important for us to be able to help people through the process over time (it’s also been very rewarding). One of our users (let’s call her Lindsay1) in particular has been making aggressive payments on a 30% interest rate card. 30% is an extremely high interest rate. Roughly, it costs you about $1 per day for every $1,000 you carry over every month on the card. According to her ReadyForZero progress, Lindsay has paid off over $6,000 in just a few short months. The ReadyForZero team has been cheering her on every step of the way and, as of this writing, this card now has a zero balance.
However, not everyone has been supportive. Her progress triggered some punitive actions by her bank. We were surprised to learn that Lindsay had received a letter from Bank of America that said they were reducing her credit limit by $6,000 to $600 because she had ‘sufficient’ balances and credit. The bank believes that Lindsay is a bad credit risk, and it is acting in its own self interest to reduce its risk. Unfortunately, this can have significant consequences for her credit score. Here is a copy of the letter:
Credit utilization ratio and credit score
Your credit score depends on several factors, including payment history, amount of credit utilized, and other factors such as length of credit history (how long you’ve been in the database)2. About 30% of your FICO score is determined by the amount of credit utilized, including the percentage of credit that you’ve used. Utilizing less of your available credit is a good thing because it shows lenders that you have more ‘breathing room’ and don’t ‘need’ the credit. Paying off credit card debt decreases your utilization, while a lowering of your credit limit increases your utilization.
So, if a bank lowers your credit limit, this increases your credit utilization, and can cause a decrease in your credit score with no action on your part. This can trigger a domino effect, causing other banks to react to a score decrease by lowering their limits as well3.
When Lindsay found out that her credit limit had been reduced by about $6,000 to $600 this crushed the excitement she had about paying off the card. It just seems in bad taste that Bank of America would do this just before the card was paid off4. Also, Lindsay was not in dire financial circumstances, her credit report showed a debt-to-income ratio5 of less than 25%. We were worried that this would negatively affect her credit score, possibly causing other banks to do the same.
We convinced her to get on the phone with Bank of America. The customer rep that answered the phone was unable to help. When Lindsay asked to speak to a manager, the rep quickly passed her on to a ‘credit analyst’. This credit analyst was matter of fact, almost intimidatingly so, quickly stating facts about Lindsay’s credit situation. He asked about her income, and whether she had other savings that would offset her debt6. Despite explanation of the situation, the rep was unwilling to re-establish the previous line of credit, saying that Lindsay had ‘sufficient’ credit and balances. Although it didn’t happen here, sometimes a credit analyst for your bank will refer you to a credit counselor. If they do, read our post about credit counselors. However, the credit analyst we were speaking to did offer to lower the interest rate on all of her Bank of America cards, something which will save her about $800 in interest on another card.
If this happens to you
Here is what you can do:
- Always open the mail from your bank. If a bank lowers your credit limit to just above your balance and you spend on the card, you could be assessed fees.
- Don’t be nervous or intimidated. Call. Explain that you are trying to pay off the debt on your card. The customer service representative that you first speak to may be unable to help. Ask to speak to a supervisor or a credit specialist.
- Indicate how long you’ve been with the bank. If you have other accounts with the bank (such as a savings or checking account), be sure to mention that.
- Update them on any information which makes you look better. If your salary has increased recently or you have savings, say so. The only way they have access to this information is that you report it.
- Stay motivated! The best way to avoid problems like this is to stay on track and pay off your cards. If this happens to you, send us your story at firstname.lastname@example.org or in the comments below.
What this has to do with ReadyForZero
People are trying to do the right thing. “The system” should enable that. It should reward that. Banks don’t have all the information they need, and in trying to protect themselves, sometimes they can hurt you in the process. We’re your advocate, and want to help you take control of your finances again. Occurrences like this are too common. Has this happened to you? Help others by leaving a comment and telling us what happened.
- Lindsay Lohan is rumored to have $600,000 in credit card debt. This story is NOT about Lindsay Lohan. [↩]
- For more information, see: http://www.myfico.com/crediteducation/whatsinyourscore.aspx [↩]
- This is similar to a behavior known as ‘Universal Default’ which was made illegal in 2009 by the CARD act. These laws prevent banks from raising interest rates on a card in response to a missed payment on any other card, but don’t prevent them from lowering limits. Preventing a ‘domino effect’ was a major motivation in outlawing Universal Default. Details about the law are available here. [↩]
- Not to mention the fact that they lowered to limit to just above the current balance. Any new charges would have made her go over the limit. [↩]
- Computed as a ratio of monthly debt obligations to monthly income [↩]
- This is important – banks do not have access to income or savings information from a credit report. This is information that you self-report, if they have it at all. [↩]