A credit card company can lower your account’s spending limit at any time, and it won’t have to provide notification unless the change will bring your credit line below your existing balance, thereby triggering penalties. But, for most consumers, the potential credit score implications of a credit limit decrease are far more troublesome than decreased spending power.
A lower credit limit can indeed affect your credit score, but the real question is how?
The answer has to do with the way in which credit scores are ultimately calculated. And that, of course, means the extent of the damage might vary based on the particular scoring model used.
The portion of your credit score most relevant to credit limit decreases is the “Amounts Owed” component, which accounts for roughly 30% of your overall score. This aspect of your credit score takes into account not only the number of credit card and loan accounts that you owe money on as well as how much you owe, but also your Credit Utilization Ratio. In other words, how do your existing balances compare to the available credit that you have yet to tap into?
Credit scoring companies calculate credit utilization individually for each of your accounts as well as on aggregate for all of them combined. When a bank lowers the spending limit on one of your credit cards, the change affects these ratios differently, especially if you have an existing balance on the affected account. The following is a basic overview of how that might play out:
- If you have zero balance when the issuer decreases your credit limit, the credit utilization ratio for this individual account will not change. Let’s say that you had a $5,000 spending limit and your bank brings that down to $2,500. $5,000 / $0 and $2,500 / $0 both result in a 0% ratio.
- When you have an existing balance, your account’s utilization ratio will increase (that’s a bad thing). If, for example, your balance is $1,000 and your limit falls from $5,000 to $2,500, then your credit utilization will rise from 20% to 40%.
- Regardless of whether or not you have a balance on the particular account whose limit is lowered, your overall credit utilization ratio will likely rise. That is because you likely have existing balances on other lines of credit, and the lowered limit on the one credit card account will bring down your aggregate available credit. The change in utilization might not be significant, but it will still reflect less favorably upon your financial situation.
How to Minimize the Impact
With the above in mind, it should be clear that there are a few steps you can take to minimize the impact a lower credit limit has on your credit score. They include:
- Paying Down Amounts Owed: Whether you owe money on the account whose limit has been lowered or simply have a ways to go to pay off other loans, increasing your monthly debt payments will help to counteract changes to your credit utilization and potentially even foster improvement in that area. Making it a priority to pay off the card whose limit has been lowered will especially pay dividends.
- Opening a New Credit Card: Opening a new credit card won’t help reduce your credit utilization ratio for the account with the decreased limit, but it will increase your overall available credit and thereby improve your aggregate utilization ratio. It will also give you another trade line that, if used responsibly, will add positive information to your major credit reports and help to cancel out whatever may have caused your credit limit decrease in the first place. Keep in mind, however, that new accounts have a temporary detrimental effect on your credit standing.
- Maximizing the Positive Information in Your Credit Reports: The fact that credit utilization only accounts for a portion of a credit score’s Amounts Owed section, which itself represents only about 30% of your overall score, means that improvement in other areas can help devalue a utilization increase brought about by a limit decrease. So, if your credit card company does lower your spending limit, you can mitigate the effect on your credit score by improving your payment habits, increasing the number of trade lines that are considered in good standing on your credit reports, disputing errors and omissions, paying off debt, etc.
When a Lower Limit Could Actually Help Your Credit Score
It’s interesting to note that a lower credit limit can actually be a good thing for certain consumers. More specifically, if you have trouble spending within your means and therefore habitually incur debt that you cannot afford to pay off, a lower limit could keep your expenses in check and ultimately foster lifestyle changes that will gradually bring down your credit utilization ratio. Not only that, but the lower limit will also decrease the odds that you’ll miss payments or even default on your debt, which can cause serious damage to your credit.
Many consumers actually request credit limit decreases in order to effectively save themselves from their own bad habits.
While a credit limit decrease can ultimately affect your credit standing, the impact is neither guaranteed nor necessarily significant. The extent of the damage resulting from a lowered spending limit depends on whether or not you carry a balance on the affected account as well as what other information you have in your major credit reports.