If I asked you to describe the profile of the riskiest (most likely to default) credit card borrower, what would you say? Would you say things like they pay their bills on time, revolve small balances, and never approach their credit limits? Or, would you describe them as maxing out their card, missing payments, and exceeding their credit limits? Clearly, the latter is going to be the riskiest profile.
Now, describe to me the profile of a credit card user who is going to be the most profitable to the issuer. Would you say things like they pay their bills on time, revolve small balances, and never approach the credit limits? Or, would you describe them as maxing out their card, missing payments and exceeding their credit limits? Again, the latter is going to be the most profitable to the issuer.
What we’ve just identified in our little exercise is this: the riskiest credit card users are also the most profitable credit card users. And even though no credit card issuer would ever admit to this, they really do want a mixture of card users who trip up from time to time. Their biggest risk management dilemma is being able to tell the difference between a cardholder who is going to default and one who is simply going to remain a cash cow.
A missed payment is very profitable to the card issuer if the consumer “cures” or catches back up. Not only has interest been incurred but a late fee of approximately $35 has also been assessed. And, in some cases, the late payment can trigger an increase in the cardholder’s interest rate, thus making any future revolving balances more expensive.
Keep in mind that missing payments if very different from refusing to pay or defaulting on your obligation. This is what we refer to as a non-default delinquency, and most large credit card issuers have between 1.8% and 10% of their population in this stage of delinquency.
Exceeding Credit Limits
The credit limit on your card is the upper bounds of your spending limit, but that doesn’t mean it’s a hard and fast cap on your spending. Some credit card issuers are actually fine with you exceeding your credit limit by a small amount. Today, over-limit fees run around $35 but you have to give the card issuer permission to charge it.
And while this might make you sound like you’re in control, you really aren’t. Thanks to the CARD Act the credit card issuer has to get your “opt in” before they can charge you the over limit fee but if you choose to withhold permission they’ll just deny your transaction.
Ignoring Grace Periods
I’m not referring to the grace period you have before your bill is due. I’m talking about the grace period before your introductory rate or teaser rate expires. There are more 0% balance transfer and 0% on purchases offers hitting mailboxes than I’ve seen in the past 20 years. But, that 0% only lasts for between 6 and 18 months, depending on the card. If you’re still carrying a balance after the introductory grace period expires, you may have to pay interest retroactive to when you opened the card.
Applying For Credit With Poor Credit
This might seem counter intuitive, but credit card issuers don’t mind you applying even if you’ve got poor credit. First off, if you’ve got poor credit but still qualify, then you’ll be what’s referred to as “adversely approved.” That means you got approved but with less than stellar terms. This means you won’t be getting even an average interest rate, which is about 13% to 15% right now. You’re more likely to be approved in the 20 percent plus range.
And, if your credit is so bad that the creditor denies you, it’s not the end of the world for them either. Many credit card issuers have a subprime subsidiary that can approve you for a subprime credit card alternative. Of course, the terms include very low limits and rates in excess of 30%. For some of these folks, it might be best to wait until their credit is in better shape.
John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a contributor for the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. The opinions expressed in his articles are his and not of Mint.com or Intuit. Follow John on Twitter.