How lowering your card limit hurts your credit score
Shutting down some of your available credit hurts a key scoring ratio
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Dear Speaking of Credit,
If I want to lower my credit card limit voluntarily, will it have a negative effect on my credit score? – Carolyn
I’ll start with a question for you: Why? Why lower your credit limit when, as you’ll see, the good arguments are only against – not for – voluntarily lowering a card limit?
Scoring impacts from a lower limit arise from the “amounts owed” credit scoring category of calculations that makes up 30 percent of your score. This set of calculations measures how much debt you owe, most noticeably through credit utilization (balance/limit) percentages – both on an individual and combined card basis – that can raise or lower a score. Lower utilization indicates less risk and leads to a higher score.
When a credit limit is lowered, the combined or individual card utilization percentage can:
- Rise, if the same balances now comprise a larger proportion of the combined limits, or
- Remain the same, if balances are $0, very small, or the limit reduction is quite minimal.
Consider the protection of your credit score against the effects of limit reductions to be just one of the top two reasons for paying cards in full – or owing very little – each month. The other reason is the money wasted on high interest when carrying a balance.
Now let’s take a look at how utilization can rise – or not rise – following a limit reduction:
- With a card having a last-reported balance of $500, if you lower the credit limit from $1,000 to $500, your utilization will climb from 50 percent ($500/$1,000) to 100 percent ($500/$500).
- With a card’s last reported balance at $0, you can lower the credit limit from $1,000 to $500 and still arrive at 0 percent utilization. ($0/$1,000 or $0/$500 = 0 percent).
Maintaining a $0 balance can easily be accomplished in a couple of different ways:
- Avoid using the card, opting instead for another of your cards with a high-enough credit limit to continue charging at the same pace, but without a utilization increase.
- Continue using the card while paying your charges before the next statement/closing date to avoid their inclusion in the next statement/closing balance that will influence your score’s utilization.
Either of the above practices will protect your credit score against utilization jumps in the short run, though using the card occasionally and paying for charges before the next statement/closing date is the best long term way to ensure a high score. Otherwise, if the card goes unused for too long, the card company could close the account due to inactivity. This would remove the closed card’s credit limit from future utilization calculations, which could raise your utilization and lower your score.
If your utilization goes up due to a limit being lowered, how many points should you expect to lose? Unfortunately, reliable scoring estimates are hard to come by. Let’s refer then to a score simulation conducted by FICO, the credit scoring originator, in which two consumers and their different credit profiles were examined upon maxing out a card:
- The lower scorer (upper 600s) lost 10 to 30 points when utilization rose from 40-50 percent to 100 percent
- The higher scorer (upper 700s) lost 25 to 45 points when utilization rocketed from 15-25 percent to 100 percent.
In a nutshell, this means that the higher your current score, the more points you have to lose by a now-lower limit raising your utilization percentage.
Lastly, if you’re concerned about any score impacts from the limit being dropped “voluntarily” by you rather than having it lowered by the card company, don’t be. It may seem that a consumer taking the initiative to lower a limit to avoid overspending is being “responsible” and should be rewarded with a higher score. Or, perhaps the consumer’s request may come from knowing about some impending financial trouble that her creditors don’t, in which case an argument can be made for the score being lowered.
None of the above apply, however. A credit report does not indicate who initiates a limit change – card company or consumer – so there can be no scoring effect based who requested the limit lowered.
All of this suggests that if you want to restrain your spending or reach some other goal involving your card’s spending limit, achieve it through some means other than lowering the credit limit. Yet, should you go ahead and lower the limit anyway, at least you have been forewarned of the worst possible scoring outcome – higher utilization – and how to avoid it.
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