Responsible borrowing can protect credit score from limit cuts

By Jeremy M. Simon

Credit Score Report

Jeremy M. Simon is a former staff reporter for CreditCards.com who covered credit reporting and scoring issues. Ask a question. 'Credit Score Report' stories

Dear Credit Score Report,
We have a Chase card that had a $50,000 credit limit. We never abused it or had high balances. About the highest we had was $4,000 to $5,000 about a year ago when we bought hearing aids. We never had any late payments, used it occasionally for different purchases to make sure it was getting used. We did pay off the balance when we got a notice they were raising the interest rate. Now, we got a letter in the mail that they lowered our credit limit by $30,000 from $50,000 to $20,000. None of our other cards have done anything like this, but now we are concerned that they might when they see this on our credit report. What is the impact of this huge credit limit reduction on our credit score? By the way, we have no late payments on our mortgage or car payments either. -- CJ

Hey CJ,
Banks' decisions to cut credit limits can hurt borrowers' credit scores, but in your case, a history of responsible borrowing should prevent serious damage.

In losing a portion of your line of credit, you certainly aren't alone. During recent years, banks have seriously tightened lending standards -- including slashing credit limits -- even for cardholders with good credit. Those lowered limits change the credit scoring component known as the utilization ratio, which compares borrowers' debts to their credit lines. The result can be especially damaging to borrowers with a heavy debt load, something you have been careful to avoid. "Credit scores are partially based upon the ratio between your debt and your available credit, and so a drop in a credit line could affect your score," says Lauren Bowne, staff attorney at San Francisco-based consumer rights group Consumers Union. "But this reader sounds like they've done exactly what they needed to do to maintain a high score," she says.

One of the smart things you've done is pay off the balance on that Chase card. That means even if your limit comes down, your utilization ratio won't change. "To calculate the utilization rate, you divide the total balances by the total credit limits. Zero divided by any number is still zero. If you have no balances, your utilization rate is still zero, no matter how much your credit limits are reduced," says Rod Griffin, credit bureau Experian's Director of Public Education. For cardholders who do carry a balance, having their credit limits reduced produces the same result as running up their balances -- a higher utilization ratio. "However, your reader says they typically keep their card's balance very low, so their utilization was also low," says Craig Watts, spokesman for FICO, creator of the most commonly used credit score. "Everything else being equal, it's unlikely that the drop in their credit limit had a noticeable effect on their FICO score," Watts says.    

That doesn't mean, however, that leaving your credit card unused is the best strategy. "Maintaining zero balances for many months actually won't help your score because it doesn't say anything about your current ability to manage credit." Watts says. Banks may also take a negative view on plastic that goes unswiped. Peter Garuccio, spokesman for the American Bankers Association trade group, explains that since it costs banks to maintain open lines of credit, a lender may decide to trim inactive credit lines and re-allocate that unused credit to another borrower. "If they're not using it, maybe that money can be used somewhere else more effectively," Garuccio says.  

In fact, Chase may have reined in your credit line due to inactivity. Bank spokesman Paul Hartwick notes that Chase regularly evaluates its customers' lines of credit and adjusts those lines accordingly. "We may lower lines for customers who are showing signs of increased risk or inactivity, and we may raise lines for our most creditworthy customers," Hartwick says in an e-mail. Based on what you've told me, CJ, you appear to fall into the "inactive" group.

And you may be right to be concerned about other banks following Chase's lead. While it's illegal for a lender to raise interest rates on a card for mistakes made on another issuer's card -- a practice called universal default, which was banned by the Credit CARD Act -- banks are still allowed to change other terms. "The CARD Act unfortunately says nothing about reducing credit limits," says Consumers Union's Bowne. That doesn't give you much protection. Banks "can reduce a consumer's credit limit for whatever reason, so long as it is not discriminatory," says Chi Chi Wu, staff attorney with the National Consumer Law Center.

Still, just because banks can reduce your credit limits, it doesn't mean they will. According to the ABA, it's unlikely -- although not impossible -- that a bank would decide to lower a limit purely because another bank did so. "I find it very unlikely that a single event would be enough of a factor, but that's possible," Garuccio says, adding that it's not in a bank's best interest to engage in unnecessary business practices that could lose them customers.

While the lenders consider their business decisions, you can take action to protect yourself by following several suggestions:

• Contact your banks. Try calling Chase's customer service and asking them to reconsider the limit reduction. "A customer whose credit line has been reduced can always contact Chase to discuss it. The customer may be able to share other information, such as salary or other details that may enable us to increase their credit line," Chase's Hartwick says. While you're at it, you may also want to request limit increases from your other banks -- although some financial experts warn this can result in account reviews that leave you with even worse terms.
• Use your card. Since inactivity can lead to closed accounts, regularly making small charges will help you keep that Chase account open and maintain a good credit score. Of course, remember to always make on-time payments and don't go overboard with your charges. The "FICO score is not about using a lot of credit, it's about how reliably you repay whatever debts you do incur. So this reader may want to use his credit card on small purchases often enough to keep the card active and demonstrate good credit behavior," Watts says.
  
• Keep overall debt levels low. In addition to careful use of that Chase card, continue to maintain good borrowing habits across all your accounts and take on new debt only when necessary. "Pay off your balances as much as possible and if you can't pay them off, keep low balances on high limit cards," Bowne says. That's something you appear to have done all along, which is why you should be fine despite the lowered limit. "It's possible this drop won't affect their score at all," Bowne says. "It just totally depends on what their other credit lines look like and how much revolving debt they have out there."

Good luck!

-- Jeremy 

See related: To preserve credit score, don't leave credit cards unused, Credit card lending standards keep tightening, Fed report says,Credit card reform law and you

Jeremy M. Simon is a former CreditCards.com reporter who wrote about credit scoring, economic data, credit card crime and other issues. He is based in Austin, Texas. He is a graduate of Vassar College and has previously worked for Thomson Financial in New York City, where he wrote about the stock markets, and Texas Monthly, as well as several publications in Austin.

Published: May 18, 2010

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