In the wake of the 2008-2009 economic meltdown credit card issuers and banks adjusted their underwriting and risk assessment practices by increasing credit score requirements and also adjusting the credit limits of existing cardholders. This is often referred to as the “flight to quality” and is a common practice that occurs in times of economic stress. And, as was predictable, credit card issuers are again lowering credit limits and, in some cases, closing the cards of inactive or underactive cardholders.
Just because your card issuer lowers your credit limit, it doesn’t mean you’ve done something wrong with the management of your card or cards. It’s not meant to be a punitive response. It is, instead, a common practice by card issuers when there is uncertainty in the economy or workforce, as we are experiencing now because of the Coronavirus pandemic.
What is a credit limit decrease?
A credit limit or credit line decrease (they’re the same thing) occurs when your issuer lowers the uppermost boundary of your card’s spending capacity. So, for example, if you have a credit card that has a $10,000 credit limit it means you can charge products and services up to that amount. That amount of spending power has essentially been pre-approved by the card issuer when they opened your account.
Card issuers can reduce your pre-approved spending limit. They can do this, legally, for a variety of reasons. One of those reasons is to adjust the card’s limit to be more in line with the spending and usage patterns of the cardholder. Another reason is to mitigate the card issuer’s risk if the credit quality of the cardholder has deteriorated since the account was opened.
For consumers who have credit cards that are used sparingly, or not at all, it should not come as a surprise if a card issuer reduces that card’s credit limit. And, it should also not come as a surprise if that card issuer closes the card altogether.
What is the impact of a credit limit decrease?
There is a possibility that a credit limit reduction could lead to lower credit scores. There is a metric in credit scoring systems called the “revolving utilization” ratio. This ratio considers the relationship between your credit card balances and your credit cards’ credit limits. If your balances are using up too much of your limits your credit scores can suffer.
Calculating your revolving utilization ratio is actually pretty simple. Pull one of your credit reports and grab a calculator. Take the sum of the credit card balances on your credit report and divide it by the sum of the credit card limits on your credit report. That is your revolving utilization ratio and it should, optimally, be as low as possible.
When your credit card issuer closes a card or otherwise reduces your credit limit, you lose the value of that credit limit in the calculation of the revolving utilization ratio. For example, if you have a credit card with a $10,000 limit and a $2,500 balance then your utilization of that card is 25%. If, however, your card issuer lowered the limit to $5,000 then your utilization would jump to 50% and your scores could suffer as a result.
What to do if your card issuer lowers your credit limit
If your credit card issuer lowers your credit limit, there are a few things you can do to mitigate any potential impact to your credit scores. First, you can certainly contact your card issuer and ask them to reconsider their decision. They may see your reaching out as evidence that you value the higher limit and, thus, reinstate the previous limit. There is no guarantee they will change their mind though.
You can also reduce your credit card balances in order to maintain a lower utilization ratio. By lowering your balance by the same amount as your credit limit was reduced, your utilization ratio stays the same. As such, your scores will not be impacted. Finally, you can certainly open a new credit card. A newly opened credit card will have a credit limit and once that limit is reported to the credit reporting companies any credit scores calculated on your credit reports will take into consideration that new unused credit limit. You should keep in mind, however, that opening a new card will result in a new credit inquiry on one of your credit reports and a new account likely on all three of your credit reports. These types of things can lower credit scores, albeit slightly and for a limited period of time.
Will a lower credit score always be problematic?
To the extent your card issuer lowers your limit and your scores do go down as a result, this doesn’t mean you’re going to feel some sort of adverse impact to your borrowing capabilities. For example, someone whose scores go from the mid 800s to the low 800s isn’t going to miss a beat because their scores still indicate they are an elite level borrower and are almost void of credit risk.
The only real issue with a lower credit score is if the lower score causes you to move into a higher risk tier. For example, if your scores went from the low 700s to the mid 600s, that’s a meaningful score change. The way around this, of course, is to work to earn the highest possible scores so that changes to credit limits are more of a nuisance and have no actual real-world impact to your credit risk.
The views and opinions expressed in this article are those of the author (credit expert John Ulzheimer) and not necessarily those of VantageScore.
