Are Credit Card Companies Lowering Your Credit Score?

By Debbie Dragon   

The economic slowdown isn't just shrinking investment portfolios, it's shrinking credit card limits, too. Many credit card companies are trying to reduce their risk of credit card defaults by hiking interest rates, lowering credit limits or both. It doesn't seem to matter whether or not you've got a strong history of paying your bills on time or you've made your payments late — no one, apparently, is immune to credit card limit reductions.

New credit card rules that take effect in July 2010 will make it difficult, if not impossible, for credit card companies to make these rate and limit changes — but until then, there isn't much to stop them from doing so. Lenders justify decreased limits by reasoning that cardholders have less money available to pay what they owe.

Learning that your credit limit has been lowered can be awkward if you happen to discover your lower limit when you try to use your card, but the repercussions of a lower limit extend further than that.

A lower credit limit not only means you have less purchasing power available, but it can also lower your credit score. Here's why:

Less available credit increases your debt utilization percentage

When your credit limit is decreased, you suddenly have a higher percentage of debt utilization. Your credit score calculation considers how much credit is available to you, and how much of that credit you're actually using. If your available credit is reduced, you're suddenly using more of your available credit, making you appear riskier to potential lenders.

Borrowers who spend most or all of their available credit have a very high debt utilization percentage; if credit card lenders lower your available credit, you don't have to spend more to look like you have.

Going over-the-limit can happen just like that

In extreme cases, credit card holders have reported that their credit card limits have been lowered to less than their current outstanding balance. Suddenly, without making any additional purchases, the cardholder is faced with an over-the-limit fee for having a balance greater than the credit limit.

In addition to a higher debt utilization and a potentially lower credit score, you could end up getting charged an over-the-limit fee!

Tips for individuals facing decreased credit limits

While there's nothing you can do to prevent your credit card companies from lowering your credit limit, you can put yourself in a better position if it happens to you:

• Avoid carrying a balance from month to month on your credit cards so that a lowered credit limit won't increase your debt utilization as much.
• Reduce your credit card debt as quickly as possible to minimize the effects of a lowered credit score if your limits are lowered.
• Consider a balance-transfer offer to increase your available credit (and lower your debt utilization percentage) if your existing card limits are decreased.