Does A Credit Limit Decrease Affect Credit Score?

Does a Credit Limit Reduction Affect Your Credit Rating?

Your credit limit is the most money that you are allowed to spend on the credit card that has been issued to you. Whenever one applies for a credit card, the credit card company provides the customer with a credit limit at the time of account opening. At some point, the issuer may reduce your limit due to several factors even without you realizing that your limit has been reduced. This leads to another question that circulates in the minds of credit cardholders – does my credit limit affect my credit rating? Let's find out.

How Credit Limits Are Decided

When you fill out a credit card application form, the issuers use your credit report and credit scores to determine how creditworthy you are. From this credit check, they offer you a credit line they believe aligns with your creditworthiness. Factors that determine your initial credit limit include.

Income level – The companies are interested in your ability to pay back the loan by having adequate income.
Current credit limit – This may mean that you are given a lower limit if you hold other credit cards with high balances.
Credit score – Your credit score provides the issuers with information regarding your performance on credit in case you have used it before.

In general, applicants receiving higher scores and income will obtain higher initial limits. This is because many issuers look at your account now and then if you are making consistent and timely payments, they will increase your limit.

When and How Card Issuers Lower Credit Limits

Once you start using it, the issuer observes your behavior regarding the credit provided to you. If the issuer observes certain behaviors that it considers risky, it may cause it to reduce its limit. Common reasons for decreased limits include.

Balancing near the limit – if you constantly keep balances near your limit, the issuer will adjust it to a more suitable level.
Late payments – this shows that you might not be able to pay the minimum amount needed due to over-commitment. The issuer may decide to reduce your balance to a more reasonable amount.
Late payment history – By reflecting on your credit reports, issuers can lower credit limits on existing cards depending on the new credit score.
Recession fears – in this aspect, issuers may reduce customer limits across accounts to avoid any default in cases where conditions worsen.

When your issuer reduces your limit, you will receive a written notice usually 30 days to plan on how you are going to manage your expenses with the new limit.

About How Credit Limit Cuts Impact Credit Ratings

Most cardholders are concerned that a reduction in their credit limit will hurt their credit score. However, an increase or decrease in credit limit does not affect the credit score straightforwardly. Here are the key points to understand about how credit limit decreases affect your credit score.

Utilization Ratio A lower credit limit can impact your score in one way, but not directly. Your credit utilization ratio – a factor that has a great impact on scoring – might rise.

Your credit utilization ratio equates your total balances across all of the cards to the total credit limits. Professional opinion suggests that this percentage should be below 30%. As an example:

You have two credit cards

For Card 1, the limit is $5,000 while the balance is $2,000. Card 2 has a credit limit of $3,000 and the balance carried forward is $500.

Total limits: $5,000 + $3,000 = $8,000 Total balances: $2000 + $500 = $2500

The following formula was used to calculate the average of the ratios: The number of times the credit facility has been accessed = (Total Balances/Total Limits) x 100 = 31%.

If your Card 1 issuer suddenly drops your limit to $3,000, your ratio changes to.

New total limits: $3000+3000= 6000 Unchanged total balances: $2,500

A new ratio of utilization = 2,500/6,000 = 0. 42 or 42%

It’s bad your limit was reduced and that’s why your ratio increased, even though your balances didn’t change. If the credit utilization ratios go above 30%, it can start to subtract points from the credit score. Thus, although a lower limit itself does not lower scores, a higher resulting utilization might if enough misuse were detected.

On-Time Payments The second example of how a lowered credit limit can impact your score is that if due to the new limit, you are somehow unable to pay your monthly statement on time, your score will be affected. The credit scoring factor that impacts the credit score most is the payment history.

If you are unable to pay at least the minimum due because your limit was reduced significantly, then the late payments that are reported on the credit report will result in a score decrease.

New Credit Applications

A third way that a reduction of credit limits could hurt scores is through the application of credit to make up for reduced buying power in the card with the lowered credit limit. Requesting multiple new cards within a short period may be viewed as potentially risky by other card issuers. New accounts and hard inquiries hurt the credit score, and having too many or opening new accounts can lower your score for a while.

Measures to Ensure Credit Rating Is Not Affected

While you may not be able to control the card issuer lowering your limit, you can take proactive steps to minimize impacts on your credit score.

Be timely - Always pay at least the required minimum amount by the due date for all your credit cards so that you don’t incur late charges and your score doesn’t get dented.
Reduce balances – Ensure that your balances are kept below 30% of your new lower credit limit to avoid your credit utilization from increasing. This is because it may be wise to reduce balances on other credit cards to create space under the lowered credit limits.
Avoid applying for new credit – Do not open more credit accounts to compensate for lower purchasing capacity. Any appearance of too many hard inquiries or new accounts on your credit reports may impact the scores.
Negotiate with the issuer of the card – You should kindly discuss with the card issuer the problems that result from the reduced limit. They may accept to raise it again or you may find them willing to compromise and come to the middle figure.
Consider account closure – Depending on features such as annual fees, the account’s age, and other effects on your credit report, you may decide to close the account. So just make certain that you have sufficient credit available to cover the costs of the investment.

The Takeaway

This is quite annoying and worrying to handle considering that credit limits can be reduced unpredictably. But in most cases, the decrease itself probably will not lead to negative impacts on your credit scores if you do not allow it to affect your capability and willingness to pay all your credit obligations responsibly. As for credit control before and after the change, it is equally crucial to shield your scores.

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