An excellent article for anyone having or considering getting credit cards. Home buyers should adopt this strategy 12 months before buying.....
When Credit Card Companies Lower Your Credit Limit
Has this happened to you? It may have happened and you didn't know it because it was tucked into the fine print of your recent bill. But if you aren't using the full limit..... Does this action by the credit card company help you or hurt you!?!?!?!?
It will hurt!! Plain and simple.
There is a term used by the experts in credit scoring.... And that word is Utilization. We are referring to how much of your revolving credit lines that you are currently using. And this is about 30% of your FICO Score.
So how can this hurt? Let's start with an example:
Joe owes $750 on his Visa card. The limit is $2500. Joe is currently using 30%(750/2500) of his credit limit. Experts agree that you should strive to keep that utilization % below 30% and the lower the better. Why? Because once you start approaching the higher percentages.... The FICO Scoring Method sees you as a great risk. Think about it.... Someone with 30% utilization vs someone with all of their credit cards maxed out.... Who is the better risk? Well, FICO knows.... and the person with the high utilization will have a much lower FICO Score as a result.
Ok.... So Joe is being responsible. His hot water heater breaks and he put that purchase on the card to the tune of 30% utilization. But then the credit card company lowers Joe's limit to $1000 to reduce their exposure to risk. Overnight, Joe went from a responsible 30% to utilizing 75%(750/1000) of his credit limit. Ooooops!!! Now what? Well, it is quite possible that Joe's respectable 720 credit score falls into the high 600s. Let's say 660 or so. What is the impact? Go try and buy a car with a 660 FICO and 720 FICO and see what interest rate difference you get. Try to buy a home on a conventional mortgage with a sub 680 FICO Score and see the if you are eligible for PMI.
But, Tom, I pay off the balance in FULL each month? So this doesn't affect me!!
Not so fast.... If you put $800 travel expenses on that $1000 limit credit card and that gets reported to the credit bureaus on the 4th of the month..... Yet you pay your bill on the 5th.... What number will FICO use? That's right, they will assume 80% utilization and dock you many points for it right then and there.
So, how can you protect yourself?
Keep more than one credit card.
Spread out large expenditures over a few cards.
Open a store card for that one time purchase(hot water heater example)
Know when your credit cards report your balance and pay history to Experian, Equifax & Transunion so you can pay off/down those cards before you apply for that big purchase like a car or new home.
Note: FICO says that it adds up all of your limits and all of your balances to calculate FICO. However, I have seen people suffer greatly by maxing out one card when they had 3 other cards with zero balance. Don't ask me why... This has been experienced by me more than once.
This credit scoring tip has saved many of my clients thousands of dollars... And it could save YOU many thousands too!!!
Did you know: That if a credit card company raises your interest rate that you have a right to cancel the card and pay it off under the old terms**?
** Remember: If you close that account, it lowers your total revolving credit available balance and could raise your 'utilization' which we discussed.
I write about Texas Home Loans , live in the Dallas, TX area and lend across the entire Great State of Texas!!