In an interesting reversal of trends, some credit card issuers are now automatically lowering customers’ credit limits as a means to reduce risk. In the past, the industry had been known to increase the credit limits of customers who were using credit responsibly. Now these companies are starting to lower limits for customers in response to a drop in their credit score, a late payment, or the addition of new lines of credit.
Credit card issuers claim this practice is good for users because it helps prevent them from getting over their heads in debt and is a better system than raising the interest rates of higher risk customers which is the more traditional way to account for credit risk.
While lowering limits is a better mechanism for consumers in general, there are two potential effects of this method of risk management that credit card users need to be aware of.
First, realize that your credit limits could change at any time. Credit card issuers are required to inform you by mail whenever they are lowered, but these notices are frequently dismissed as junk mail and consequently are never read. Because of this, some consumers have found out the hard way that their credit limits were lowered when they exceeded their new credit limits, and ended up having to pay large “over-the-limit fees”. Make sure you know you current credit limits before you max out your cards.
Second, remember that a large component of the formula used to calculate your credit score is the amount of credit extended to you, and the amount of that credit you are currently using. Your credit score could take a big hit if your credit card provider lowers your credit limits because it will simultaneously lower the amount of credit while increasing your ratio of debt to available credit. To lenders, this could make it look like you are closer to overextending yourself and in turn, a higher credit risk. For credit card users who find their credit limits lowered because of a drop in their credit score, having their credit score lowered even further as a result of the adjustment amounts to a double penalty.
If your credit limits are automatically lowered, you can help minimize the effect it will have on your credit score by making sure to pay down your credit card debts. Experts suggest paying down high credit card balances and recommend a debt to available credit ratio of around 35% to optimize your credit score.