You were denied for that new credit card. Your interest rates went up unexpectedly. Or maybe your credit card account was closed altogether.
It’s not a pleasant experience, but credit card issuers are well within their rights to take adverse actions like these — as long as they follow the rules.
What Is an Adverse Action?
Adverse action describes a negative action that a lender can take against you. Such actions may occur in response to your behavior, after a review of your credit reports and scores, or as a result of policy changes by the lender.
When it comes to credit cards, the most common types of adverse actions are:
- Denials of credit
- Credit limit reductions
- Interest rate increases
- Account closures
If you’re applying for a card and your credit doesn’t meet the issuer’s standards, you may get a denial of credit instead of being approved. Or, if you already have an account and the issuer sees that your credit has gotten worse, it may decide to reduce your credit limit or increase your interest rates.
Credit cards are like open-ended loans. Essentially, a card issuer is loaning you money over and over again. As a result, you can expect your card issuers to check up on your credit frequently. Issuers need to make sure your risk level stays the same and that you continue to meet their credit standards.
There are two main federal laws governing adverse actions in the world of credit: the Fair Credit Reporting Act (FCRA) and the Equal Credit Opportunity Act (ECOA).
To put it simply, the FCRA covers consumer transactions. It requires lenders to give you a notice if negative credit information was the basis of the adverse action.
The ECOA covers both consumers and businesses. It requires lenders to describe the specific reasons why the adverse action was taken.
Here’s how it breaks down:
- The FCRA requires lenders to say that negative information was the cause of any adverse action.
- The ECOA requires lenders to provide specific reasons why adverse action was taken against you in that notice.
The FCRA covers applications for credit, like credit cards, along with other types of applications like employment and government license. The ECOA covers applications for credit as well, along with requests for credit limit increases on existing accounts. If you want to dig into the details of these laws, you can read more at Consumer Compliance Outlook.
What Does an Adverse Action Notice Include?
Lenders, like credit card issuers, must explain why they take adverse actions by sending adverse action notices, also referred to as declination letters.
If a credit report or score was used as the basis of the adverse action, the card issuer is required by law to provide you with a notice containing information about your credit. That notice can be delivered verbally, by email, or in writing. Most adverse action notices are sent by mail.
The ECOA requires adverse action notices to be sent within 30 days of the lender taking negative action against you. An exception to that rule is if you apply for credit, the lender gives a counteroffer, and you don’t accept the counteroffer; in that case, the lender has 90 days to send the notice. (The FCRA has no time requirement like this.)
According to the FTC, all adverse action letters based on credit checks must contain:
- The specific reasons for the adverse action (and an explanation that the credit reporting agency used — either Experian™, Equifax®, or TransUnion® — didn’t make the decision).
- The credit score that was used for the application (if applicable), with reason codes explaining four key factors affecting your score.
- The credit reporting agency (or agencies) from which your credit report was pulled.
- The contact information for that credit reporting agency.
- Your right to a free credit report from the credit bureau used in the decision (must request the report within 60 days).
- Your right to dispute any incomplete or inaccurate information found in the credit report.
There are some other requirements as well, but these are the most pertinent.
The purpose for the contact information is so you can contact the credit reporting agency and request a free copy of the credit report that was used by the lender. This is your right under the Fair Credit Reporting Act.
Since July 2011, if a credit score is used as part of the lender’s decision, that score must be disclosed in the adverse action letter. If multiple scores are used, the lender must disclose at least one of them.
If a lender takes a negative action against you that doesn’t involve checking your credit, you’ll usually still receive an adverse action notice explaining the reasons for the lender’s decision. However, that letter doesn’t have to include the above credit information.
This could happen if you’ve been a bad customer to that specific lender, such as making late payments or defaulting on your debts. Adverse action notifications can also come from background checks for employment applications, which may or may not involve your credit.
What Types of Adverse Actions Are There?
Speaking specifically, there are several different types of adverse action, including:
- Denial of credit: Your credit card application is denied.
- Adverse approval: The issuer counteroffers with worse terms; you can accept if you wish.
- Interest rate increase: Your credit card’s APR goes up.
- Credit limit reduction: Your credit card’s credit limit is reduced by some amount.
- Credit limit increase denial: You request a higher credit limit, but the issuer thinks it would be too risky.
- Account suspension: You can’t make new credit card purchases until you fix the situation.
- Account closure: Your credit card account is closed.
We discuss the three broad types of adverse action — denial of credit, adverse approval, and negative change in account terms — below, including the many different kinds of negative account changes that issuers can make.
Adverse actions can be taken against existing account holders as well as people applying for new credit. Many consumers are surprised to learn that their credit card issuers will continue to monitor their credit reports and scores periodically, perhaps even as often as once per month.
These routine credit checks are commonly referred to as “account maintenance.” The purpose behind account maintenance is to help card issuers ensure that the creditworthiness of their current customers has not changed since their initial applications.
If you have credit problems, even with an unrelated lender, then your card issuer may take steps to reduce its exposure to your elevating risk. Therefore, if your credit scores drop, your credit card issuer might reduce your credit limit or increase your interest rate for future purchases.
This is why your activity with one credit card could affect all your other credit cards.
If your card issuer presents you with a negative change of terms, you’ll have the option to opt-out, but this means you’ll need to close your credit card account. You’ll then have a specified period of time to finish paying off the balance.
If you use the card after receiving notice of a change in account terms, it indicates that you’re accepting the new terms.
A negative change in account terms can feel awful when it happens to you. Yet, it’s important to know that these changes don’t always happen because you did something wrong. In some cases, the standards of the issuer may change, and the new standards could mean that you no longer qualify for the same type of credit account you once did. Policies may change for any number of reasons, including the recent successes or failures of the lender, or reactions to the current and expected economy.
Denial of credit
A denial of credit is probably the easiest type of adverse action for most consumers to understand. It’s no secret that credit card issuers rely heavily on credit reports and scores to guide the decision process whenever you fill out a credit card application.
If your credit meets the card issuer’s minimum qualification standards at the time of your application, you’ll likely be approved for a new account. However, if your credit does not satisfy those minimum standards, you’ll be denied and an adverse action letter will be provided explaining the reason(s) for your denial.
Some of the possible reasons might be:
- Credit scores are too low, for various reasons
- Limited credit experience
- No credit file
- Poor credit performance with the lender
- Not enough income or debt-to-income ratio is too high
- Derogatory credit information, like bankruptcy, collection accounts, etc.
- Inability to verify personal information or income
- Incomplete application
Wondering if you’ll qualify for that new credit card? You can use pre-qualified credit card offers to check if you’ll be approved for a particular card before you apply (without impacting your credit scores), or to see the types of cards you’re likely to qualify for first.
When you apply for a new credit card account the potential results are not just approval or denial. There is a third option, known as an “adverse approval.”
Essentially, an adverse approval is a counteroffer a lender makes if your credit is not strong enough to qualify for a new account at the terms requested.
You might, for example, apply for a credit card with:
- No annual fee
- A 0% introductory interest rate
- A regular purchase APR of 10.99% after the intro rate
Yet upon review of your credit scores and reports, the card issuer might offer you a card with terms like these instead:
- A $99 annual fee
- No special introductory rate
- A regular purchase APR of 14.99% APR
Of course, you would be free to accept or decline the counteroffer. Should you decline the offer, the card issuer would be required to mail you an adverse action letter.
Interest rate increase
An interest rate increase is one type of negative change in account terms that an issuer could make after you open a credit card.
It’s pretty simple: Your interest rate (APR) goes up. This could be just your purchase APR, or it could be your balance transfer and cash advance APRs as well, if your card has those features.
Although the concept is simple, the practice of raising interest rates comes with a host of restrictions and requirements.
When a card issuer raises your interest rates, it usually needs to provide you with a notice 45 days before the increase takes effect. At this point, you can opt-out of the change, but in that case, you’ll need to close your card account and pay off the remaining balance.
If a card issuer raised your rates because of a drop in your credit scores, it must review your account again in 6 months to look for improvement. If your scores have improved during that time, the issuer must reconsider your interest rate.
In most cases, card issuers can’t raise the interest rates on credit accounts that have been open for less than one year. The exceptions to this are if an account is 60 days delinquent, the prime rate changes, or a promotional APR period ends.
Depending on the reason for the rate increase, the card issuer may institute a penalty APR (usually around 30%). This could happen if you’re late on a card payment, if a payment is returned, or if your credit scores drop far enough.
Depending on the card issuer, the penalty APR could last for at least 6 months, or perhaps indefinitely. In some cases, you can get penalty APRs taken off your account by making six on-time monthly payments.
The CARD Act of 2009 prevents retroactive interest rate increases in most cases. These are increases of interest rates on existing balances (from past purchases). If a card issuer raises your interest rates, it can usually only do so for future purchases.
However, if you become severely delinquent on an account and your payment is at least 60 days late, the card issuer can retroactively raise the interest rates on your current balances for that particular account.
Before the CARD Act, card issuers were able to apply retroactive interest rate increases to existing balances if you made a single late payment to anyone, including other lenders. This was known as “universal default,” and it’s a good thing for consumers that it’s no longer permitted.
There are a couple of other situations in which your interest rates may rise, but not as a result of adverse actions. In these cases the issuer does not need to provide a 45-day notice:
- The prime rate goes up: Most credit card APRs are variable, which means they’re based on the federal prime rate. If the prime rate goes up, your interest rates will typically go up by the same amount.
- Your promotional APR period ends: When a promotional APR period ends (such as 0% for 12 months), your rate will be increased to the regular APR.
Credit limit reduction
Credit limit reductions are another type of negative change in account terms, and they’re quite simple.
Your credit limit, or credit line, is like a loan being extended to you by the card issuer. The better your creditworthiness, the more comfortable lenders will be giving you large credit limits.
But if a card issuer decides that it’s too risky to provide your current credit limit, it may lower your limit to reduce risk. This reduction could be small, like 20% of your credit limit, or it could be very large, like 80%.
Credit limit increase denial
Did you know that you can request higher credit limits on your credit cards? It’s usually a quick and easy process and, in most cases, the request can be made online.
But credit card issuers don’t have to grant requests to increase credit limits. Instead, they can deny them or provide a counteroffer if you request an increase by a specific amount.
Some of the possible reasons why your credit limit increase might be denied include:
- Your account is too new.
- You had a credit limit increase recently.
- You have too much total available credit already.
- You’ve opened too many new credit accounts recently.
- Your income isn’t high enough.
- The balances on your credit cards are too high.
- You’ve had late payments or other problems.
- Your credit and credit scores aren’t good enough in general.
If your credit card issuer decides that you’ve been a bad customer for some reason, such as late payments, it could suspend your credit card account.
This means that your account is still open, but your charging privileges have been revoked. The card will be declined if you try to use it for new purchases. A suspended account does not have any special effect on credit scores and appears like a normal, open account on credit reports.
A card issuer may suspend your account if it’s worried that you won’t pay back your debt and it wants to keep your current balance in check by preventing you from spending more. Or, your account could be suspended if your credit limit is reduced and your balance meets or exceeds your new limit.
Suspended accounts can usually be reactivated by meeting the requirements of the card issuer, which will be unique to your situation. You may receive instructions on what to do, or you can contact customer support to learn how to reactivate your account.
If your account was suspended for being delinquent, for example, you’ll probably be required to pay the minimum amount due and any late fees to make the account current. If you need to pay back a lot of debt, you may be able to work out a payment plan with the issuer.
If the reasons for the account suspension aren’t addressed and you don’t remedy the situation, the issuer will likely close your account altogether.
The most serious type of negative account change is account closure, also known as account revocation. Account closures are usually permanent.
A card issuer might close your account if you fail to live up to your end of the contract. This could be not paying back your debts or otherwise abusing the terms of your credit card agreement. Or, the issuer could see negative activity with other lenders and decide to drop you for being a risky customer. In still other cases it could just be a new policy decision by the issuer, which doesn’t have anything to do with you in particular.
Some common reasons why issuers close accounts include:
- You’ve defaulted on your credit card debt and the account was sent to collections (usually for payments past due by 180 days).
- Your account has been inactive for some length of time.
- Your credit scores dropped.
- Your credit reports show negative activity of some kind, like late payments or a bankruptcy.
- The standards of the issuer changed and you no longer qualify for that credit card.
- That credit card is no longer offered by the issuer.
Having a credit card account closed can potentially have serious consequences for your credit scores, especially when it comes to credit utilization and collection accounts.
The status of an account helps determine the effect it has on your credit. An account closed in positive status (such as for inactivity) will remain on your credit reports for up to ten years, and can continue to have a positive effect for that whole time. An account closed in negative status, on the other hand (such as for being in default and sent to collections), can remain on your reports for up to seven years. It may have a negative effect on your credit scores (sometimes severely) as long as it’s present on your reports.
What Should You Do After Getting an Adverse Action Notice?
Adverse action notices aren’t the end of the world. Depending on the cause, it could be a rather harmless situation. Of course, in some cases, an adverse action notice could be a sign of a serious credit problem.
If you receive an adverse action notice, use this as an opportunity to review your credit reports and learn what lenders are looking for in a good customer.
- Look at the reason(s) for the adverse action: If it’s a simple problem, like an incomplete application, you can probably just reapply with complete information. Other issues, however, might not be remedied so easily.
- Look at the credit score key factors (reason codes): These will tell you the major factors currently affecting your credit score — the reasons your score isn’t higher. Maybe you have too much debt or your credit profile is too young. Whatever the cause, once you know what’s holding your credit scores back you can set out to improve in that area.
- Check your credit report: If your credit played a role in the decision, you’ll be able to request a free copy of the credit report used by the lender. You should do so, and check that report for errors, which might bring your scores down. If you find any mistakes, take steps to correct them.
- Commit to using credit responsibly: If the adverse action is a direct result of your behavior or your credit profile, take the time to understand how to use credit cards responsibly and improve your credit scores.
You should be able to improve your credit by addressing the issues revealed in the adverse action letter. After making some changes, you can try applying for that new credit card again, or requesting another credit limit increase.
Or, depending on your situation, you may need to adjust your credit card application strategy. Maybe you were applying for a card that you can’t qualify for with your current credit history and level of income, and you need to lower your sights a bit.
Whatever the reason, adverse action letters don’t signal the end of your credit adventure. Instead, they can be a wake-up call, showing the weak spots in your credit profile and giving you the information you need to improve.