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Over the past year, millions of U.S. credit cardholders have seen their credit limits lowered. And while there are signs that the economy may be stabilizing, don’t expect the credit line cuts to stop any time soon. According to the Wall Street Journal, by the end of 2010 card issuers might have scaled back the collective credit available on credit cards by as much as $2.7 trillion. Some analysts predict that cardholders will see a total reduction of up to 57 percent of their credit limits.
For cardholders who pay their bills on time, carry a low balance, and maintain good standings with other creditors, these credit card line cuts may seem unfounded and unfair. After all, consumers who hold up their side of the agreement expect credit card issuers to hold up theirs as well. However, although some limit decreases appear arbitrary, especially for people with good credit, there is method behind the madness. By educating yourself about the red flags credit card companies look for to determine which cardholders to lower rates for, you can reduce the probability of credit limit cuts going forward.
The standard advice for avoiding credit limit cuts still applies:
- Pay credit card bills and other bills on time;
- Use all your credit cards regularly;
- Don’t wait till the last minute to pay credit card bills, and pay more than the minimum due;
- Carry a low balance, not higher than 30 percent of the credit limit and preferably below 20 percent.
In addition, while few people realize it, credit card companies not only look at how much of the credit line credit cardholders use, but also where they typically use their credit cards.
Every time cardholders’ swipe their credit card, card issuers record the purchase data. This is part of card issuer’s fraud protection program; it enables card issuers to zero in on unusual purchase patterns, which could signal credit card fraud or theft. For example, when a credit card always used in Orange County, CA is suddenly found making purchases in Taiwan, the charges will be checked against the cardholder’s purchase history in the card issuer’s database, triggering a fraud alert.
However, credit card companies also use the data from cardholders’ purchase history to draw conclusions about their lifestyle, discretionary income, and risk profile. As far as card issuers are concerned, regular expenditures at premium establishments indicate financial confidence, while purchases at discount stores could indicate money concerns. For example, a cardholder frequently shops at Crate and Barrel, credit card companies will likely conclude that he or she fits the profile of a high discretionary income/low risk consumer. If, however, if a cardholder begins to make frequent purchases at the local Dollar General, card issuers may draw the conclusion that he or she has become pressed for cash and now falls into a higher-risk category. When contemplating credit limit cuts, card issuers will then be more likely to single out that cardholder for a cut.
While the conclusions card issuers draw from tracking purchases are not necessarily accurate reflections of a person’s finances, they do provide credit companies with some general indicators from which to assess financial risk—and cut limits.
In short, to protect yourself from credit line cuts, in addition to following the standard advice above, consider using cash when shopping at grocery stores, dollar stores, and other discount outlets.
In addition, immunize yourself against the effects a credit limit cuts by maintaining a low balance, so that if your credit line is chopped, it won’t impact your debt-to-credit ratio. The debt-to-credit ratio accounts for almost a full third of the FICO credit score, so a credit line cut that significantly increases the proportion of debt in relation to the credit available could result in a credit score drop. As a general rule of thumb, experts recommend keeping credit card debt at 30 percent or less of the total available credit. Ideally, of course, pay off the balance in full each month. This will not only ensure a that the debt-to-credit ratio stays low, but will also prevent any credit line decreases from negatively impacting your score.
