How credit card companies capitalize on your FICO freefall

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Back in the day, you got a credit card with a certain interest rate, and unless you failed to pay your bill on time, that was that. There was sometimes a clause in your credit card agreement that gave the credit card company the right to adjust your rate at certain intervals. But that was often negotiable, and the people who most often had their rates changed were those who failed to pay their bills on time.

Over the years, the credit card agreements became more restrictive. The companies say this is because bad credit card holders were costing them money, and they were only recovering those costs with higher rates and fees.At some point, credit card companies started offering lots and lots of "promotional" rates to customers who opened new cards, transferred balances, or met some other requirements. Those rates were great for those who carried balances on their credit cards or wanted to make a larger purchase and pay for it later.

Soon came the loss of the promotional rate. Pay your bill late or pay less than the minimum, and you were likely to see your rate skyrocket. But that seemed fair, didn't it? You were given a really low rate, so long as you played by the rules. If you didn't follow the rules, you got a penalty.

But then came the questionable stuff. Oh, I'm sure it's all laid out in the fine print of the credit card agreement. And I'm sure it's legal and all, and I know that when the consumer applies for a credit card, she or he agrees to it. I'm just saying it seems a little bit unfair to the credit card holder.

The credit card companies decided to do frequent checks on your credit to make sure you were paying all your other credit card bills on time too. Pay late on an unrelated account, and you are again at risk of losing your promotional rate.

What does a completely separate credit card company have to do with the company offering you a more competitive rate? Well the credit card industry says delinquency or default on other accounts raises a customers risk to all of their creditors. Okay, I buy that. Yet it seems a little bit radical to penalize a consumer on an account that's still in good standing based upon activity on a different account.

Want to take this one step further? Well credit card companies have. Now they are raising rates if your credit score drops! You might be current on all your accounts, but if your credit score goes down – bam!!! Welcome again to world of penalty interest rates.

Again, the credit card companies are falling back on the idea that a consumer with a lower credit rating has a higher risk of default. I can't argue with that logic, but I can say that credit scores are not necessarily the best measure of a customer's trustworthiness. Why? Because the calculation of a credit score is a complex, misunderstood, and somewhat-secret process.

There are some common factors that many consumers know affects your score – paying late, having too high balances on cards, and not having much of a credit history. But there are many other factors in play which might affect credit scores in a way that consumers aren't so aware.

Say for example, that a person trying to buy a home applies for a mortgage with three different companies in order to find the best rate. Those mortgage companies will each request the consumer's credit report, which is likely to lower the person's credit score, at least temporarily.

How about the consumer who has a financial crisis and relies on credit cards temporarily, causing outstanding balances to rise? The consumer has stayed current on all payments, but the high balances could cause her credit score to drop.

Even a somewhat simple and innocent move, such as opening a new credit card, could cause a consumer's credit score to drop.

The above consumers may represent a higher risk to a credit card company because of their changing financial situation. However, if all their bills are still paid on time, it's hard to accept the idea that the credit card company may still penalize them.

Is it fair that consumers who are paying all their credit cards on time are being penalized by credit card companies, simply because of a credit score that has decreased? Again, credit card industry supporters say it's in the agreement so consumers should have no complaint. I say that the consumer might know about it and might consent to it, but it doesn't mean it is fair.

A Senate subcommittee is hearing testimony on this issue and lawmakers may consider legislation to curb what some call these abusive practices by credit card companies. The Wall Street Journal reports that Citigroup, J.P. Morgan Chase and Capital One are voluntarily discontinuing the practice of raising interest rates based upon decreases in credit scores. Time will tell if other companies will follow suit.

Forensic accountant Tracy L. Coenen, CPA, MBA, CFE performs fraud examinations and financial investigations through her company, Sequence Inc. Forensic Accounting. The Association of Certified Fraud Examiners honored Tracy as the 2007 winner of the prestigious Hubbard Award and her first book, Essentials of Corporate Fraud, will be on bookshelves in March 2008.
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