Why is American Express Trying to Close Accounts?

American Express is trying to limit its exposure to what could end up being record losses due to widespread credit defaults. Four states have already reported unemployment numbers above 10% and several others are knocking on the door.

Economists still expect things to get worse before they get better, with relief expected to come in late 2010 or even later. While some economists have called this the “Great Recession,” it might more appropriately be noted as a depression. We will not know until much later whether economic conditions will have officially deteriorated to the point that this economic cycle could be a depression.

While some card issuers have been reducing credit limits to reduce their exposure to potential losses, American Express has instead offered an incentive of $300 for certain accounts to be paid off and closed. While American Express is not disclosing how it determines which accounts it is selecting for the offer, there is some speculation that it could be tied to the little known “bankruptcy score” that is maintained by credit bureaus.

Recent Growth

American Express reported it had 65.4 million credit cards in use during 2004. By 2008, that number had jumped to 92.4 million accounts. While American Express was very successful at achieving rapid growth, it also may have overextended itself.

Some economists predicted an economic downturn, noting that a correction was needed in response to hyperactive housing markets and out-of-control mortgage lending. However, few could have anticipated that the economy would reach such disturbing levels.

American Express is making the offer at a time in which most other card issuers are also pulling back. Fortunately, American Express is providing an incentive and a choice for cardholders. Other card issuers have not been so generous.

Effects on Credit

If you take American Express up on their offer, there will be some impact on your credit score. Once the account is closed, it will benefit your credit history less and less as time goes on. The effects will be worse for someone who has held the account in good standing for many years. Accounts held less than 2 years would have little impact upon closing. The length of your account history is part of a 10% component of your credit score calculation which measures length of credit history.

Second, your credit score will benefit from having paid off the balance. If you paid cash to pay off the account, this will boost your score by reducing the total outstanding debt, which comprises 30% of your credit score.

If you transfer the balance to another credit card, then this will have very negative consequences. Not only will you take away the long account history that you have established by closing the account, you will also experience an increase in your credit utilization rate. This can cause your score to drop many points.

Should you Take the Offer?

There are several things to consider before deciding whether to take the offer. First, how will it affect your credit. If you have lots of outstanding debt, then the impact could be very negative. On the other hand, if this is your only balance and you pay if off with cash, it could benefit your credit.

Another consideration is your cash reserves and credit needs. Draining your savings and eliminating a line of credit could give you fewer financial options if your income situation takes a turn for the worst. Investment challenges and job losses are key events that could necessitate that you keep a buffer in your finances. Savings and credit are two key tools that allow you to maintain options.

Also, if you have come to depend on the rewards associated with the account, then you would lose those if you closed the account. In the end, consider your situation and do what will benefit you the most.

Credit card companies have begun raising interest rates and making other changes to accounts in order to increase revenues and reduce default risks. The problem is that some actions may have actually increased default risks. Here are the changes that some major card issuers have made in 2008:

• American Express changed terms of their credit card accounts to increase interest rates on purchases and fees for late payments. Foreign transaction fees have increased, but they are still less than what others charge.
• Bank of America has raised interest rates on many of their card accounts. Also, many cardholders have recently had credit limits lowered. My limit was recently raised, so any reduction in your credit limit is apparently a result of periodic account review inquiries that suggest financial weakness.
• Capital One changed their minimum payment calculation. This could result in some cardholders experiencing an increase in their minimum payments.
• Chase has implemented substantial minimum payment increases from 2% of the balance to 5% of the balance. Additionally, a $10 fee has been added to many accounts. These changes do not apply to all accounts. Most cardholders that experienced the changes had taken advantage of a low-interest balance transfer offer at least 2 years ago. Affected cardholders could see their minimum payments increase 150%. For example, a $10,000 balance would require a minimum payment increase from $200 to $500 a month.
• Citibank has raised its purchases interest rate and has increased the penalty rate charged to late payers. In addition, Citi’s Sears cardholders may no longer have extra payments applied toward the following month’s minimum payment.
• Discover had only minor changes that matched what other card issuers had also done. They removed the cap from balance transfer fees.

The Treasury has declared a deadline of July 1, 2010 that all credit card issuers must comply with new regulations. These restrictions will keep card issuers from raising interest rates on existing balances for “any time or any reason.” They will also lock in interest rates on existing balances, so that any rate increases would only apply to new purchases.

Many cardholders have experienced frustration with the recent changes. Some consumers have expressed anger at changes made to existing balances that they believed were locked into a deal for the life of the balance. Other cardholders have allowed accounts to lapse because they cannot afford to make the higher payments.

Some relief is on the way to cardholders that find they cannot afford to keep up with their payments. However, the regulatory relief will not reach most of them in time to make a difference. Instead, if you are in trouble now, you should get help through credit counseling before you find yourself in a hole from which you cannot escape.

If you believe that your credit scores are still good but you have experienced adverse changes to your credit account terms, then there is a good chance that your bankruptcy risk score has changed. It could be the reason for your high-risk classification.

What is Universal Default?

Universal default is a practice of some credit card companies that increase your credit costs if they see signs of weakness on your credit report. In practice, a consumer that falls behind or goes over-the-limit on one credit card account could experience interest rate hikes and reduced credit limits on their other credit card accounts, even those issued by other creditors.

Why Did Universal Default Disappear?

Universal default was phased out by credit card companies in 2006. They did this during a period of increased Congressional scrutiny of credit card practices.

Congress debated increasing regulations imposed on credit card issuers. The major credit card companies instead tried to prove to Congress that they could police themselves, and that more regulation was unnecessary.

The major component of universal default is the “any time for any reason” right to increase rates or reduce available credit to a cardholder. Members of Congress wanted to outlaw this practice. As a result of these discussions, credit card issuers voluntarily stopped universal default practices in 2006.

Why is Universal Default Returning?

Universal default is returning to credit card agreements for two primary reasons:

1. First, credit card issuers are facing mounting losses from credit card defaults. In addition, many of these firms are also experiencing other subprime credit losses that further hammer profits. Credit card issuers are trying to stop the bleeding, and these increases in revenues should offset some losses.
2. Congress is allowing considerable latitude among financial institutions following the collapse of several commercial and investment banks. Credit card issuers are betting that Congress will allow for such practices in the interim until financial markets stabilize and begin their recovery.

Most credit card issuers are bringing back some form of pricing increases, whether specifically through universal default pricing or through across the board changes. Already, American Express, Bank of America and Citibank have begun raising rates of cardholders regardless of consumer behavior.

If you have a credit card account, you may or may not see an interest rate increase as a result of these changes. They are not necessarily affecting all card accounts by these issuers. However, if you have shown any signs of distress on one card account, you should be prepared for subsequent reactions from your other credit card issuers. Universal default will likely raise your interest rates and increase your minimum payments, possibly beyond what you can reasonably afford!

Purchases Rate Increasing

The standard APR for purchases is increasing as a way to boost the bottom line. This represents the largest potential gains for revenue, as well as the biggest increase in costs for most cardholders.

The default rate is also going up. This is a penalty rate that is charged if you give the card issuer a reason to raise your rate. This penalty may be assessed for a late payment or by exceeding your credit limit.

The cost of cash advances is also going up. You should also expect that the amount of your credit limit available for cash advances to be less than you could withdraw in years past.

Fees Increasing

Penalty fees have gone up in recent years. We decline to list exact late fee amounts because these frequently change industry-wide. Whereas most card issuers charged $25 – $29 as a late fee just a few years ago, these fees have increased to $29 – $39 recently. Even $45 is no longer out of the question.

Late fees charged by American Express are similar to those charged by other major card issuers. All of these late fees and over-the-limit fees have increased in a relatively short period of time.

In addition to late and over-the-limit, American Express is raising its foreign transaction conversion fee from 2% to 2.7%. This is still below the standard 3% charged by most other card issuers. This affects most people only while traveling internationally.

What to Do

The best way to protect yourself is to avoid overuse of your credit card accounts and repay the balances as quickly as possible. This may be harder now if your rate has increased. This will cause your monthly payment to increase without any additional amount going toward repaying the principal balance.

If you are juggling several credit card accounts, then you will likely notice that American Express is not the only card issuer that is raising rates. Indeed, you could see your credit card payments increase by 20-50% as a result of the announced increases, depending on which credit cards you possess.

Struggling to repay debt can cause conflict in your daily life. It can endanger your net worth and your credit rating. It can strip away your wealth, leaving you with little to retire on.

If you are having trouble being able to afford your American Express and other card payments, then you might want to consider credit counseling. A nonprofit credit counseling organization that serves you might be able to take the sting out of high interest and high payments.

If your only account is American Express, and you have experienced a recent job loss or emergency medical event, then you might wish to contact American Express directly and request a hardship. This short-term relief might provide a 6 month window to get caught up and pay down your balance.