Wednesday, September 3, 2008

Always Know Your Creditor


Always know your creditor. Let me say that again: always know your creditor. I can’t emphasize this enough. Given how difficult the credit market has become, this message – always know your creditor – has taken on even more importance.

Creditors have always watched your every move, but creditors are being even more vigilant today. As a result, you should know exactly what your creditors like and don’t like. If you’re not aware of their tendencies, then you’re operating without a road map or a plan (and you know what I think about plans).

Are you considering a mini-application spree? What does your creditor think about new accounts? How about a bunch of new inquiries? Don’t know? Find out. I wouldn’t be making a credit move right now without knowing what my creditors think of particular credit moves. American Express, for example, seems to hate new accounts (American Express is like that jealous girlfriend who slaps you for looking at a pretty girl who walks by). In fact, next time you apply for a credit card, check your credit report. I'll bet you'll find that American Express has done an account review. American Express likely gets notified, through a service it subscribes to, whenever a new inquiry shows up on your credit report. American Express, in other words, takes new accounts seriously. If you’re a new American Express cardmember, you should think twice about running out and grabbing a bunch of new accounts.

Similarly, American Express hates balances. Even though you have a credit card (as opposed to a charge card) with American Express, does that mean you should feel comfortable carrying a balance from month to month? As unfair as it is, you'd be much better off paying in full each month. American Express got its start in the charge-card business. It has always expected its customers to pay in full. When you leave balances on your American Express credit card, you're asking for trouble. Remember that.

Ah, but you don’t have an American Express card, you say. You’re going to apply for that new Nordstrom card without any worries. Not so fast. You’re aware that Nordstrom detests inquiries on your credit report, right? Three or more inquiries are enough for Nordstrom to reject you.

Not interested in Nordstrom? Instead, you’re interested in grabbing that great Pentagon Federal Credit Union (Penfed) card that I highlighted six weeks ago? How is your debt-to-interest ratio? Is it high? Does Pentagon even care about such things? It does. It behooves you to find out what ratio would likely result in a denial for you. What about too many new accounts? Will Penfed think that you are "pyramiding debt?" Even though Penfed is misusing the term, there is a good chance that it will accuse you of -- and deny you for -- pyramiding your debt.

Here is how you actually pyramid debt, by the way: You have two cards. Those two cards have a combined credit limit of $20,000. You are using a combined $10,000. Thus, you are 50% utilized. In an effort to get your utilization down, you apply for two more cards. Assume that you get approved for $20,000 in combined limits. You now have $10,000 in balances on $40,000 in available credit. You are now using 25% of your available credit. That's better for your scores, but you have not reduced your overall debt at all.

Three months later, you buy a sweet 50" LCD flat screen. Cost? $4,000. You also buy a nice surround sound system. Add another $3,000. You are also interviewing for a job, and you buy two suits and some new shoes. Add another $3,000. You now owe $20,000 on those credit cards. But you have $40,000 in total limits. Thus, you are using 50% of your credit. You then decide to apply for two more cards. You get approved for another $20,000 in limits. That brings your total available credit to $60,000. You are now using $20,000, or 33% or your available credit. Feeling pretty good about your utilization, you decide to apply for that Penfed card. You get denied for pyramiding. Penfed says that you have been increasing your available credit -- and making your utilization ratio look better -- but you haven't actually been paying your debt down. In fact, during the past six months, your debt has actually doubled. That's how pyramiding works. And it's something that Penfed doesn't like.

Of course, Penfed often says that people are pyramiding debt, even when they're really not. If you get a lot of new accounts, in a short period of time, Penfed could accuse you of pyramiding debt for that reason as well. Unfortunately, that's not what pyramiding is, but Penfed uses the term liberally -- and wrongly, in my opinion.

Meanwhile, I know someone who has had a heck of a time with Bank of America lately. See, he likes to keep balances on his card. Always has. So why is Bank of America reducing his limit every time he makes a payment? I can only guess that Bank of America, like so many other banks, is trying to trim its exposure to what it considers higher-risk customers. My buddy is quickly learning what “chasing the balance” means. My buddy’s mistake is that he wasn’t keeping his finger on the credit pulse. What worked in 2004, when anyone could get credit, is not working now. My buddy wasn’t paying attention. He is now.

I’ve got yet another friend who, earlier this year, made a $180,000 payment to Countrywide, which brought his home equity line of credit (HELOC) balance to zero. Under normal circumstances, that kind of debt repayment would be smart. Who wants to pay interest on $180,000? Not me. And not my friend. Unfortunately, Countrywide immediately shut down the HELOC. Turns out that Countrywide closed the account because it said that home prices in his area had dropped significantly. The timing couldn’t have been worse.

Shortly after making that payment, business slowed down significantly. All of that free cash that he used to repay the HELOC was now with Countrywide, instead of in his own bank. He had come to rely on an open HELOC. He often used it as a cheap source of capital. Without that HELOC, he was now in a cash crunch. If he would have called me before paying that HELOC off, I could have warned him that banks were shutting down HELOCs at breakneck speed. Given his geography, I would have suggested that he pay down a portion of the HELOC, but not all of it. That wouldn’t have stopped Countrywide from trimming its exposure to my pal, but he’d still have some powder dry. He ultimately weathered the storm, but not without performing a few high-risk financial acrobatics.

Now more than ever, it makes sense to know what your creditors think. The stuff that most of us could get away with just a few years ago may not work in today’s credit environment (in fact, I know it won’t). I have changed my credit habits. I’m not applying for many accounts right now. I’m not asking for a lot of credit-line increases. I’m certainly not carrying a balance on any cards. But I am still using my cards regularly (don’t want creditors to think that my resources have diminished).

It’s unfortunate that I have to think about my every credit move, but it is what it is. Rather than fighting it, I am embracing it. I’m learning as much as I possibly can about my current creditors and my would-be creditors. I’m not making a move until I know exactly what I’m working with. If you haven’t already begun to figure out what your creditors like (or don’t), I’d advise that you start sooner rather than later.

Indeed, the sooner you do it, the better off you’ll be.

Related Articles:

10 comments:

Bob Wang said...

Maybe I shouldn't have put that $2,300 on Amex.

Bob

Credit Matters said...

Maybe not, Bob. Maybe not. Probably should have just sent me cash instead.

Take care, pal.

aversio said...

I think you'll be just fine Bob ;)

Anonymous said...

The rules have changed. It is about time somebody took the time to write about it.

Indeed, what worked in 2004 does not work now. Creditors have us between a rock and a hard place.

For example, they want us to use our cards (to show we have positive cash flow) and yet don't want us to use too much of it at once or piling on debt at an accelerated pace.

I would argue that creditors are more closely looking at the amount of monthly payments your making, in effect, showing you have enough cash to handle your current debt load.

Creditors need to grow in order to be profitable, so they want to encourage you by offering nice BT offers or line increases, and yet you are under a microscope. One wrong move due to your ignorance and they'll take back just as easily what they gave.

It is like navigating through a credit minefield. Sometimes it is just better to sit idle and wait until visibility clears up rather than moving forward and risk stepping on land mine which could really put a hurting on your credit.

I think it is prudent to stay healthy credit-wise now so when the credit markets recover, we will be in a stronger position to take advantage of the rewards that are sure to follow.

A timely topic and I thank you for writing about it.

Credit Matters said...

Anon, times have changed, indeed.

It really is a tough environment. On the one hand, make the wrong move, and you're dead. Don't make any move, and you could be dead.

At this point, I'm just not making any "sudden" moves. Trying to move around slowly and methodically.

Will be nice when we're out of this situation.

Thanks for reading. And thanks for the comment.

Anonymous said...

Great post! Can you explain the Bank of America scenario a bit more? Why would paying down a balance cause a slash in a credit limit? And what's "balance chasing?"

Credit Matters said...

Anon, sure.

Creditors don't want to see a cardmember leave balances for long periods of time. It's a sign that the cardmember doesn't have the financial wherewithal -- or means -- to pay the debt off (at least any time soon). Therefore, instead of letting the customer pay down the account slowly (and then eventually run up the balance again), the card companies are simply reducing the limit on the card whenever the balance moves lower. This way the cardmember can't keep charging.

Chasing the balance, then, occurs when the limit chases the balance lower. You pay the card down, the card company reduces your limit. You pay it off a little more, the card company lowers your limit a little more. Eventually, the limit is so low that you can't do much damage -- even if you do walk away from the debt at some point in the future.

soapdish56 said...

how do I find out what my creditors like - is it just trial and error, do I call them up and ask?

Credit Matters said...

SD, cruise around the various sites that I frequent. Creditboards.com is where you can get the answer to any question. Start a thread there and ask about a particular creditor's penchant for a particular thing you are interested in.

I've found creditboards.com to be an invaluable resource. You'll find that many of them have personal experience with the creditors.

Tonya said...

There's also debtorboards.com, cardratings.com, and the fico.com forums. Fatwallet.com is nice if you are frugal and/or like to invest. It's not so nice if you specifically want assistance with cleaning up your credit report. All in all, checking multiple sites gives a better picture of what's currently happening right now, and how you can best take advantage of it without it taking advantage of you.

Also, when visiting any of these sites, pay attention to the date a post was written.

Post a Comment