In response to the inevitable credit crunch many credit card issuers are lowering credit limits without advanced warning to cardholders. In their defense, many borrowers have shown a propensity for maxing out credit limits with little promise of repayment. As a way of hedging against potential write-offs credit card companies have decided to minimize their exposure by reducing credit limits, and therefore the amounts available to charge.

How Does a Lender Lowering My Credit Limit Affect My FICO Score?

If you are like me and are not currently using your credit cards a credit line reduction may seem harmless. However, it does have an impact on your FICO score, not because the limit reduction is viewed as an adverse action, but because it raises your credit utilization ratio. The amount of your outstanding balances accounts for approximately 30% of your FICO score. The amount you owe as a percentage of your total credit limit is referred to as credit utilization. Run this figure above 30% and your FICO score will likely take a dive.

An example. Let’s assume John Q. Citizen has two credit cards and owes $4,000 on one with a $5,000 limit, and owes $1,000 on another with a $5,000 limit. On the first card, John’s high balance-to-limit ratio of 80% is bringing down his FICO score. The second card is well under the recommended 30% credit utilization ratio, at only 20%. However, the second credit card company has decided John Q. may be a risk because he just completely a car loan application, or he is shopping for insurance and has had a couple inquiries on his credit report, or because the lender doesn’t like guys named “John.” For whatever reason they choose, the credit card company decides to chop Mr. Citizen’s credit limit in half - down to $2,500. Without charging a dime, and arguably through no fault of his own, John is now suddenly running a 40% credit utilization ratio on his second credit card, lowering his FICO score even more.

My Credit Limit Has Been Decreased. What Are My Options?

• Call to Get Your Limit Reinstated. Call the customer service number listed on the back of your credit card. Explain your situation to the customer service representative and complete the identity verification process. Automatic credit limit reductions are typically performed as the result of a computer audit. Once a human being reviews the account and considers all the factors they may be able to restore your credit limit. If not, ask to speak to someone in the credit department, or a customer service supervisor. These individuals usually have a higher lending authority and may be able to override the customer service representative’s decision (which is likely still driven by a computer model).

• Transfer your balance to another card. If you have an open line on another credit card with a higher limit, and can transfer the balance without being assessed a fee, it might be worth the effort to move the balance over to the new card. This will improve your credit utilization ratio in the eyes of FICO. Be selective - surfing balances too many times could be yet another trigger for the infamous “universal default” or an automated credit limit reduction on your remaining credit card accounts.

• Do Nothing. This actually happened to me a while back on a credit card I only owed a few hundred dollars. I called the credit card company and they refused to reinstate my limit. I spoke with a supervisor who also refused, as did a representative in the credit department. None of the three could explain to me why the limit was reduced in the first place. My FICO score had not changed, my charging patterns had not changed (accept for the fact my charging was greatly reduced), and I wasn’t shopping for new credit. Regardless, they refused to budge so I paid off the account in short order. Against my desires to tell them to take a flying leap I decided to keep the account open as closing the account would reduce my total credit line and could potentially send my FICO score lower.

It looks like Fair Isaac is reacting to this recent lending debacle by improving on its formula for creating the almighty FICO score.  Habitual late-payers will be more heavily penalized, while those of us with the occasional 1-30 day late payment will be spared a few points to the negative.  Of course all this reprogramming isn’t being done for your benefit; it is for the benefit of lenders whose bottom lines were eaten alive by sub-prime customers.

What do the changes mean for you? Unless you plan to run out and acquire new debt, probably not much.  The changes do emphasize the need to implement your debt snowball plan and start paying things off quickly.  Those with higher credit limit utilization (balance to credit limit ratio) will be hit harder in the FICO 08 scoring model, so it pays to drive those high balances down lower.

No more piggyback rides allowed. This may be one of the only positives out of the new FICO changes.  Previously, people listed as “authorized users” still got benefits of having a good credit line, even though they were not financially responsible for the account.  Many of those late-night credit repair crooks used this technique to improve scores.  They would pay a person with good credit to add someone with lousy credit as an authorized user (of course, Lousy never got a card or the number).  By virtue of being paired up with Mr. Credit Pimp, Lousy saw her credit score increase.  Under the new model only an account’s applicant or co-applicant will have their score impacted by account activity.

FICO has really dumbed down the financial industry. I guess in some ways FICO has helped to prevent discriminatory lending practices (after all, it’s just a number, not a sex, race, or age).  However, the negatives far outweigh the positives in my opinion.  Banks used to consider how long someone was on the job, or whether or not they paid their landlord on time, when considering lending money.  An employer would use interviews and a firm-handshake-test to determine if someone was trustworthy.  I remember when I worked in a new credit department of a large financial firm the only things that mattered on an application where FICO and income.

These days we look down on people with poor scores and exalt those with scores in the 800’s. Can you imagine the personals in only a few years?  Male 6′3″/220lbs/760 FICO seeking Female in the 720-760 range.

Don’t know where you stand?  Get your FICO score today!