Emily writes in the following question regarding credit card limits:
“I would like to lower the limits on two of my credit cards from $6,000 to $1,500, and $7,200 to $3,500, but I’m not sure what the repercussions would be.”
“My FICO score, according to my credit union, is currently 762.”
“I read your blog several times per week. I am happy to report that after many years of struggling, my total debt is less than $10,000 ($8,400 in student loans and $1,475 on a personal loan at my credit union). I’m on track to be debt free in a little over a year!”
Thanks for being a loyal reader, Emily. Congratulations on your progress – you are on the homestretch now, and will soon enjoy the freedoms of being without debt.
Lowering your credit limit seems to be the responsible thing to do. After all, you are eliminating risk for the card issuer by reducing the amount of potential liability they are exposed to, and you are reducing the potential for you going on a wild spending spree and adding thousands to your debt.
Keep Credit Utilization at 30% or Lower
Unfortunately, the credit scoring gods don’t quite see it that way. One of the major components of your credit score is referred to as “credit utilization.” That is, the percentage of debt you owe in relation to your credit limit.
As an example, if you owed $3,000 on a credit card with a $10,000 limit your credit utilization would be 30%, which most agree is the sweet spot, or at least the upper end of the utilization ratio. Anything higher and it actually drags down your credit score.
If you reduced that $10,000 credit limit to $5,000, but still owed $3,000, your credit utilization would double to 60%. Maintain this level for too long and your FICO score could decline.
If you are concerned with maintaining a good credit score, and 762 is a certainly a good score, it might make sense to wait until you have paid off your balances entirely to reduce your credit limits, or to close a particular credit card account. At that time, consider how much you may be spending on the card each month and ask for a limit roughly 3.5 times that amount (round up to the nearest $500 just to be safe).
Assuming you plan to spend about $500 a month on items you purchase with a credit card (utilities, gas, etc) ask for a limit around $2,000 to ensure you stay under the 30% utilization threshold. If your billing statement cycles and a higher utilization ratio is reported to the credit bureaus, you could see a drop in your credit score, even if you pay off the card’s balance each month.
FICO Scores – Who Needs ‘Em?
Having said all that, a good FICO score is most important only if you plan to borrow again. Sure, credit scores are sometimes used to make employment decisions, and insurers often use credit scores to make underwriting decisions or to set premiums. However, it’s my opinion that we have become way too dependent on credit scores these days.
Make credit decisions that work best for your financial household, not because FICO suggests doing it one way or another. In the long run, you’ll be better off for it.
Thanks again for being a reader, Emily. Best of luck knocking out that remaining debt. Write back and let us know when you are officially debt free.
Ask the readers: Have anything to add for Emily? Have you considered asking issuers to lower your credit limit, despite the impact on your FICO score? Feel free to share in the comments below.