Credit Cards Gone Wild- Issuers jack up fees to shore up earnings

As credit card companies move to limit their risks, business owners face unpleasant surprises from their credit card providers.

Owen Kusolpaisit, Southhaven, Miss.
I have a very small business and most of our debt is on credit cards. We had a 0% annual percentage rate until January 2009 that would go up to 7.99% thereafter. A few months ago my check got there a day late. The credit card company, Advanta, increased my APR to 7.99%. I just received my current statement and the APR jumped to 25.39%. When I called, a supervisor said it was done for economic reasons. How can they do that? Is it illegal? Can I report them?

By Kathleen Ryan O’Connor, CNNMoney.com contributing writer
Raising your interest rate at any time, for any reason, is perfectly legal - just check the terms and conditions on your card for the proof. But if it makes you feel any better, you have plenty of company.

Faced with the same economic pressures as other companies affected by the ongoing recession and credit crunch, credit card companies are racing to protect themselves from the costs of more defaults by hiking interest rates and slashing credit limits, even for cardholders with excellent credit histories.

Stories abound of customers waking up to find their cards less flexible and more expensive than ever before. But where a credit squeeze on an overextended shopaholic might be a blessing in disguise, credit cards are a critical source of financing for many small business owners. As bank loans and credit lines become ever-scarcer, entrepreneurs are left with fewer and fewer options.

Experts warn that the pain won’t pass quickly. One prominent banking analyst, Meredith Whitney, predicts that pullback will wipe out a whopping $2 trillion in credit lines over the next 18 months.

“Unfortunately, it’s a situation we are hearing from a lot of our members,” said Molly Brogan, vice-president of public affairs for the National Small Business Association, a Washington-based advocacy group. “There’s so little transparency in the credit card industry, so people just don’t know. [Small business owners] go in understanding they will have one deal, and then realize there are very few limits [on what credit card companies can do]. There’s not a lot of recourse small businesses can take.”

An NSBA survey in April found that 44% of small business owners used a credit card to finance their business. “That’s more than any other source of financing, including bank loans and earnings,” Brogan said. “There’s a huge reliance on credit cards.”

Even the chair of NSBA’s board, Marilyn Landis, discovered the hard way that she isn’t immune to rapid changes in the credit card market.

Landis is president of Basic Business Concepts, a company that provides CFO services. Landis’ expansion of her Pittsburgh-based business turned into a major headache after the increased activity and travel expenses on her business credit cards prompted her issuer to lower her credit limit. She intended to pay off all the expenses within a year, but that plan became more difficult when her interest rate abruptly jumped from 3% to 27%.

Plus, payment dates moved across the calendar seemingly at random each month, and the COO of her company was given the runaround while trying to make a payment over the phone. Landis was stunned at the difficulty she ran into with the card - “and I’m a finance person!” she said.

Advanta said its right to raise interest rates at will is spelled out in the terms and conditions for its cards. On the company’s Web site, those terms include this catch-all phrase: “We may change any of your account terms, including rates and fees, at any time for any reason.”

Advanta spokesman David Goodman said that each customer who receives a rate increase is notified in writing and given the opportunity to opt-out. If they exercise that right before a set deadline, they can continue paying down their existing balance at the old interest rate - even making just minimum payments - until the balance is zero. However, the credit line will be frozen, and once it’s paid off, the account is closed.

How does the opt-out option work? Advanta isn’t saying. Goodman declined to offer details about the length of the deadline and whether cardholders need make their opt-out request in writing, by telephone, or in some other way. Consumer complaint boards on the Web are full of tales from Advanta consumers who say they never received any notice of their rate hike, and who are unaware of any opt-out clause.

Forcing customers to accept higher rates or close their accounts is a way for credit card companies to triage their credit risks. The sour economy has directly hit their bottom lines: According to one analyst, delinquencies and default rates rose to all-time high in September for Advanta. Defaults on Advanta’s loans rose to 11.02% from 4.76% a year ago, and the delinquency rate rose to 6.47% from 3.22% a year ago, according to analyst Scott Valentin of Friedman Billings Ramsey & Co.

Mike Haynie, a professor of entrepreneurship at Syracuse University’s Whitman School of Business, said all of this has a snowball effect.

“A lot of people use those cards for inventory, and it’s a revolving kind of relationship between buying inventory or supplies,” he said. “When the credit card company takes away their ability to do that, it’s an instant hit on the bottom line. It’s particularly tough to swallow when it’s not because of a late payment or something like that but to reduce risk …There’s not a lot they can do.”

When companies can’t borrow, their performance can suffer, which then leads to layoffs and production cutbacks. “It’s a vicious cycle,” Haynie said. “It’s scary, honestly.”

Seasonal businesses can be particularly hard hit.

Charles McCabe, CEO of People’s Income Tax and The Income Tax School in Richmond, Va., has seen his credit limits lowered and interest rates increased on both his business and personal American Express (AXP) cards.

He tried to preserve what was left of the available credit on one card, about $15,000, by writing a check against it to deposit as cash into his business checking account, but “as soon as the check reached Amex for payment, they reduced my credit line down to the amount that was previously owed and rejected the $15,000 check,” he said.

“Their reason was that my overall credit balances with all credit cards is too high,” McCabe said. “I explained that they are high at this time of year because I operate a multi-office tax business which is highly seasonal, and that the credit lines are paid down each year during tax season. I also pointed out that I have been an Amex customer for 37 years, since 1971, and have never been late or missed a payment. They said that those factors didn’t matter and their decision is based strictly on their criteria and could not be reversed.”

Getting burned by credit isn’t a new problem for business owners. An over-reliance on consumer credit to bankroll his business almost cost Glenn Phillips his company in the downturn that followed the Sept. 11 attacks in 2001.

“The credit cards were just showing up, business and professional. We had good cash flow and I have great credit,” he said of the time before the downturn. “Just cheap, cheap, cheap money.”

That caused Phillips to be overly optimistic, and when business slowed for his Birmingham, Ala., software company, he went from using credit cards to expand his business to using them just to keep it afloat.

Phillips learned the hard way that when you really need the money is the precise moment the banks will start saying no. “I wasn’t disciplined,” he admitted.

Phillips fought his way back from the brink of bankruptcy, at one point selling his home and renting a single room to live in to save money. Today, his revamped company, Forte Inc., is stronger than ever, winning awards from software giants such as Microsoft and employing a staff of eight.

“The credit card game - if you are going to play that game, understand what is coming,” he said.