Your credit card can lower your spending limit, even if you have a good credit score. Here's how to prevent it.
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- A lowered credit limit can have a negative impact on your credit utilization ratio, which accounts for 30% of your credit score.
- Credit card companies may lower credit limits if you haven't used your card for a while, or if your credit score suddenly drops.
- To avoid having any of your credit card limits lowered, make occasional purchases with all of your cards for the sake of account activity.
When I opened a letter from American Express dated February 15, 2020, I definitely didn't expect to see that the credit limit on my
I have an excellent credit score (836 according to TransUnion's model, and 818 according to Equifax), but I quickly realized why this happened: I hadn't used that card in quite a while.
Why credit card companies lower credit limits
When you apply for a credit card, the credit card issuer looks at your credit and the ability to pay back any outstanding balance. Sometimes the decision is made by a computer in the blink of an eye. If you're approved, based on your income and credit history, the credit card company sets your credit limit.
I have four cards from American Express but only use one of them regularly, my
My less-active American Express cards are older cards that I downgraded to in order to stop paying annual fees for cards I no longer wanted. My Blue Sky card has an $8,100 credit limit and my old Blue® from American Express card has a $8,300 limit. My
After looking at my credit limits and activity, someone — or some algorithm — decided to cut my EveryDay card's limit by $10,000 to $10,500. The reason, according to the letter, was: "There has been minimal activity on your account in the last twelve months."
Inactivity is one of the most common reasons for credit card companies to lower credit limits. They may also cut limits to lower their risk with specific customers. Just because the credit card company sets a limit at a specific point in time doesn't mean your finances will always be the same. If your credit score suddenly drops, for example, the credit card company might decide to lower your credit limit.
Additionally, during the coronavirus crisis, some credit card issuers began reeling in credit limits to minimize their risk during an uncertain time.
How a lower credit limit can hurt your credit score
Your cards' credit limits factor heavily into the formula that determines your credit score. Your credit limits specifically factor into the second biggest factor of your credit score: your credit balances, or your credit utilization.
If you have high balances in relation to your total credit limit across all your card accounts, your credit score will suffer. A very low balance, on the other hand, will help your score. The credit score formula looks at the percentage of your available credit in use. Higher limits mean each purchase uses a smaller percentage of your credit limit.
When my credit limit was cut, my total available credit limits went down by $10,000. This wasn't a huge deal for my credit, as I have big limits across many cards, but for some people, it could be a bigger problem.
To better understand the impact, let's look at an example:
Assume you have a $5,000 balance split between three cards and a total available credit limit of $30,000. In this scenario, you are using 16.7% of your credit. That's well within the expert suggested limits of using no more than 20% to 30% of your available credit.
But if your credit limits are dropped to $20,000, all of a sudden you're using 25% of your available credit. That change is almost certain to negatively impact your credit score.
As a general rule, higher credit limits across your card accounts are better as long as you can manage them responsibly and don't spend more than you can afford to pay back in full every month.
What you can do to avoid a lower credit card limit
There are three strategies you can take to avoid the same fate as me:
Maintain your credit score
The first strategy to keep up your credit limits is to keep your credit score high. If you always pay on time and keep your balances low, your score should increase over time. Avoid late payments and high credit balances whenever possible.
Maintain or grow your income
Your debt-to-income ratio tells lenders how much of your income is needed to keep up with your credit-related bills. A growing income helps here, as does keeping your credit balances low.
Keep your credit cards active
For the specific reason my credit limit was cut, it's a good idea to keep cards active. Using a card at least once every few months for a small purchase should be enough to avoid having limits cut — or, even worse, cards closed — due to account inactivity.
Use a system to keep your cards under control
My wife and I have about 20 credit cards between the two of us. That's a lot of accounts to keep active. With so much to juggle, I'm not surprised my limit was cut.
To keep cards active, I use a combination of strategies. Some cards have a small recurring charge each month, like Netflix or Spotify, that I pay with auto-pay. Other cards come out every three or six months and get used once or twice before going back in the drawer.
Whatever system works best for you to keep cards active, be sure to stay on it to maintain your credit card limits and credit score. In the long run, it is a great decision for your financial health.