Have you had your credit limit reduced unexpectedly? If so, you’re not alone. In this blog post we’re going to explain exactly what you should do if you find yourself in that situation. Much of the general public is not yet aware of this, but credit card companies have been slashing credit limits on existing cards since the financial downturn in 2008. In a 2008 New York Times Article entitled Banks Trimming Limits for Many on Credit Cards, reporter Eric Dash wrote,
“Meredith Whitney, an Oppenheimer banking analyst, said the impact of the recent regulatory proposals on lender profits could be so severe that she expected the industry to pull back $2 trillion in outstanding credit lines by 2010. That would be a 45 percent reduction in credit currently available to consumers. Risky borrowers would be squeezed the most.”
So what does this mean to you? It means even if your credit limit has not been lowered, it’s something that could happen to almost anyone – without you even realizing it!1 Think you’re safe because you’re not a “risky borrower”? Think again. People with good credit and payment history are now seeing this happen to them. In order to protect credit scores, everyone will have to start monitoring their accounts much more closely.
Why Banks Are Lowering Credit Limits
This may seem illogical. Why would credit card companies decrease credit limits on existing accounts – don’t they make more money if people use their credit? What could they stand to gain from this? Ever since the downturn shocked the U.S. a few years back, lenders have gone from focusing solely on gains to worrying more about risk. Therefore, many have had to pull back on their lines of credit as much as possible and are continuing to do so years later. They just can’t afford to have everyone borrowing everything they’d been approved for in the past. There are many reasons for this:
- Customer Defaults: Since the downturn began, many people hit personal financial snags and have defaulted on credit cards, home mortgages, and the like. Loss of jobs equals a loss of income and difficulty paying bills – and since the essentials like home and food have to come first, credit cards are the first thing to get defaulted on. People stopping on card payments altogether, paying late, or going above their limits, means credit card companies are losing money already lent with no real idea if or when they’ll get it back.
- General Pull-Back on Lending: Of course not all customers have defaulted on their credit cards or even paid late, but credit card companies are no longer able to wait and see what happens and hope everyone else will pay. Across the board they are pulling back on credit limits to reduce the risk of further defaults, regardless of someone’s payment history.
- “Chasing the Balance”: This one will shock you. Let’s say you’ve never defaulted or made a late payment. In fact, you’re paying down your balances and may even be close to being debt free. You have nothing to worry about, right? Wrong! Let’s go back to the article mentioned above. Eric Dash explains, “Often, lenders will lower customers’ credit limits as they pay down their debt – a technique known in the industry as ‘chasing the balance’. This way, they are on the hook for less money if borrowers default.”
Hopefully it is now clear that credit card companies are doing everything they can to reduce their risk – and it’s not that easy to predict if you’ll be targeted. They are profiling their customers and watching their spending habits very carefully. You could be showing risky behavior without even realizing it! Any little thing can flag you. Let’s say you normally shop JCrew and suddenly you start going to Old Navy instead. They’ll notice that and may think you’re hitting a financial snag. Or perhaps you’ve started charging your groceries and everyday items. Again, this could indicate that you are struggling.2 Any change in your normal shopping behavior could indicate a problem and unfortunately, preventing them from changing your line of credit isn’t something that can be done proactively. The best thing you can do is to keep your debt below 30% of the credit available to you and never, never pay late.
How Credit Limits Work – And Why They Matter
What does all this really mean to you, other than the obvious implication that you’ll have less credit available? You may even think that’s a good thing – maybe even having a high credit limit you don’t need actually makes you nervous. So why have it if you don’t need it? Because it has a huge impact on your credit score! Your credit limit is part of your debt to credit ratio, which impacts your credit score. Let’s discuss the parts of this formula below:
- Debt to Credit Ratio: Your debt to credit ratio, also known as your credit utilization, is the amount of debt you have compared to the amount of credit available to you. If you have a $1,000 balance on a credit card with a limit of $10,000, then your ratio is 10%. What if you have two cards: one with a zero balance at a $5,000 limit and the other maxed out at a $5,000 limit? You have a 50% ratio because your total debt is $5,000 while your total available credit is $10,000.
- How Debt to Credit Ratio Affects Your Credit Score: This ratio paints a picture of you to anyone pulling your credit score. It tells them how much credit you are utilizing and thus how much room you have to spare. It also tells a lot about your financial situation because if you have a high ratio, then it may seem like you are having trouble paying for all the things you need. At the end of the day this ratio makes up 30% of your total credit score.
- How Credit Limit Decreases Affect Your Debt to Credit Ratio and thus Your Credit Score: Let’s put this all together. You now know what a debt to credit ratio is and that it is 30% of your credit score. So what does having your credit limit reduced have to do with all of this? Well, let’s say you have a credit card with a $2,000 balance and a $10,000 limit. Your debt to credit ratio for that card is only 20%. That’s great! You want to keep the total ratio under 30% in order to keep a high total credit score. Then one day your lender decides to slash your credit limit to $4,000. All of a sudden your debt to credit ratio on this card has jumped from 20% to 50% and your credit score will reflect that. So even though you didn’t default or pay late, your credit score is all of a sudden going to be much lower. All because your lender decided to reduce your credit limit.
Now that you understand what debt to credit ratio is, how it is affected by a limit decrease, and that this makes up 30% of your credit score, then the severity of this situation should sink in. And it gets worse before it gets better. Some people aren’t just getting their limits cut to be closer to their balance, but actually having them cut to below their balance. Yep. A credit card company can actually lower your credit limit so much that it is actually below what you already owe.3 Remember that $2,000 balance on a card with a $10,000 limit? Imagine if they cut it down to $1,500. You’re now over your limit! This means your credit score will drop and you are likely to incur penalties for going over your limit. And again, this doesn’t just happen to risky customers. It’s happening to people across the board, even those with solid payment histories, high credit scores, and even business accounts. So rather than being rewarded for working hard to pay off debt, you could end up getting punished for seemingly no reason.
What To Do If Your Credit Limit is Cut
Let’s say this has happened to you. What can you do about it? Many people’s first assumption is to fight it – you didn’t know about it so how could they do that to you? One thing you’ll need to know is that credit card companies are not required to notify you in advance if this happens unless the decrease will put you below your current balance and penalize you for this. The liberty to change your credit limit at will is written into most credit cards’ terms of agreement, which you have to sign to receive the card. Do you think that the credit card companies have to notify you in advance anyway, because of the recent financial reforms? Nope. According to the Truth in Lending Act, a credit card company only has to notify you in advance of a reduction in credit limit if that change will decrease your limit to below your balance and thus incur penalties4:
9(c)(2)(vi) Reduction of the Credit Limit
Consistent with the January 2009 Regulation Z Rule and the July 2009 Regulation Z Interim Final Rule, the Board proposed to retain § 226.9(c)(2)(vi) to address notices of changes in a consumer’s credit limit. Section 226.9(c)(2)(vi) requires an issuer to provide a consumer with 45 days’ advance notice that a credit limit is being decreased or will be decreased prior to the imposition of any over-the-limit fee or penalty rate imposed solely as the result of the balance exceeding the newly decreased credit limit. The Board did not propose to include a decrease in a consumer’s credit limit itself as a significant change in a term that requires 45 days’ advance notice…
Now, let’s talk about what you can do if this happens:
- Call Your Lender: Even though the law doesn’t require advance notice if your credit limit isn’t reduced to below your balance, that doesn’t mean you shouldn’t try to do something about this. Contact your credit card company and speak with them calmly to see if they can change your limit back. If you have a solid credit score and a spotless payment history, then tell them! Tell them anything else that reflects positively on your finances: a raise in salary, any savings you have, etc. This could help them see that you’re not a risk. While this doesn’t guarantee they’ll change the credit limit for you, they may at the very least lower your interest rate or do something else to retain you as a customer.
- Don’t Close Your Account in Frustration: Let’s say you call and speak with someone, then someone’s manager, and so forth – to no avail. That doesn’t mean you should just close your account in anger. Doing so will negatively affect your credit score. Your credit score is affected by length of time you’ve had your accounts open – so don’t wipe out a long-standing account in frustration!
- Shop Around: Just because you shouldn’t close your account doesn’t mean you shouldn’t look for a better one! This could be a great opportunity to apply for a balance transfer. Many credit card companies will offer an introductory rate of 0% for six months to a year on balance transfers if you have good credit. Now, that APR won’t be 0% on purchases made in the future and you are likely to pay balance transfer fees, but it may still be worth it if the fees are lower than the interest you are paying now. Plus, if you find a card that has a higher limit than the one you currently have, you can lower your debt to credit ratio. Just make sure to shop around, don’t take the first offer you see, and keep the old card open. Maximize your money by doing your research. There may be a card that offers low rates and no balance transfer fees – and that means this situation could end up being even better for your finances than before!
- Check Any Automatic Payments You’re Making: Let’s say you’re going to stick with your current card. Do you have the monthly payment to the card withdrawn from your checking account automatically? If so, check your new minimum balance (since a decrease in the credit limit could mean an increase in minimum balance due) and compare it to the amount you have coming out of your account, and adjust accordingly. The last thing you need is penalties or fees because you didn’t realize your automatic payments are no longer high enough!
- Pay Things Down if You Can: This may seem obvious, and yes, easier said than done. However, if you have some savings then it would be wise to pay down your credit card in order to decrease your debt to credit ratio. You don’t necessarily have to make a huge payment that will hurt your finances (because remember, you are still at risk for “chasing the balance”). Just try to improve it somewhat to mitigate changes in your credit score. If your credit limit has been decreased to below your balance, thus putting you over the limit, you should make it a very high priority to at least pay down enough to get you back under the limit. And if you can pay the whole balance off, by all means just do it – and do it fast before your credit score is affected by the credit limit decrease. (If you’re having trouble managing your debt, try using ReadyForZero)
Steps to Take If Your Credit Limit Hasn’t Already Been Lowered
If you’ve been lucky and your credit limits haven’t been lowered, then now is the time to proactively prevent that from happening in the future. You can’t do anything to guarantee that it won’t happen, but there are some steps you can take now to help yourself.
- Monitor Your Credit Report: Everyone is entitled a free credit report once a year. And since there are three bureaus that provide it (TransUnion, Equifax, Experian) you can actually check one every four months. Read the report carefully and make sure there are no errors – they do happen! You don’t want to get dinged for delinquencies that never happened! Keeping a close eye on your credit report is also a great way to keep tabs on your financial situation and help you stay focused on improving it as much as possible.
- Pay On Time: No matter what, make sure you pay your credit cards on time, even if that means you can only make a minimum payment. Credit card companies can charge penalties for late payments and even increase your interest rate.
- Read Your Mail: We’ve already discussed that credit card companies don’t necessarily have to notify you in advance of a credit limit decrease – but that doesn’t mean they won’t notify you eventually. So when you get mail from your lenders, don’t just throw it in the trash! The sooner you find out if something likes this happens, the better chance you have of keeping it from negatively affecting your credit score. Another thing to note: credit card companies do have to notify you of an interest rate increase. Just another reason to read that mail!
This all may sound very confusing and be even more frustrating! But the more you arm yourself with information, the stronger you will be in protecting your financial future. And that’s what this is all about! So whether this has happened to you or not, don’t let it get you down. Fight for your finances and your future!
This article is part of our Credit Card Debt Resource Center. If you’re looking for additional information about credit card debt, be sure to pay a visit!
Image credit: Mykl Roventine
- Source: Truth In Lending – Federal Register: The Daily Journal of the United States Government [↩]
- Source: Credit Card Companies Are Watching You – Stacey Vanek Smith [↩]
- Source: How to Blow Your Credit Limit – Without Spending – Kelli B. Grant [↩]
- Source: Truth In Lending – Federal Register: The Daily Journal of the United States Government [↩]