Credit Scores and Credit Limit Changes

Credit scores are influenced and change up and down to a number of attributes found in an individual’s credit report.  The FICO credit score is the most common credit score used by lenders.  In calculating credit scores, the FICO score is derived by analyzing the data in an individual’s credit report and will change as the credit report data changes. 

A number of factors are weighed in a credit report to come up with the credit score.  Factors include length of credit, payment history, amounts owed, amount of new credit, types of credit used and other factors.

One of the other factors used to determine the credit score is the amount of available credit in relation to credit outstanding.  This is further analyzed by the proportion of credit lines used or the proportion of credit line balances such as credit card balances in relation to the total credit limits on certain types of revolving accounts.  The FICO score considers the consumer’s credit limit to evaluate what is referred to as the credit utilization rate or how much available credit is being used at the time the score is calculated.  The greater an individual’s credit utilization rate, the greater the risk that person will eventually default on a credit account.

Therefore it is reasonable to find two individuals that have fairly similar credit histories and payment patterns and one of these individuals has incurred a significant amount of credit card debt in relation to their available credit limits, while the other individual has relatively low credit card balances in relation to the available credit and the two scores will be different.  The individual with the greater amount of debt relative to available credit is penalized for that position.

The credit utilization rate factor that goes into credit score models is why the common advice on credit card for consumers is to avoid running up one credit card to its maximum limit, rather it is generally believed that to maintain or improve a credit score, the credit card balances should be spread out among different cards and therefore reduce the relative amount of debt to credit limit or credit utilization rate per credit card. 

With credit cards companies reducing their credit card exposure by dropping credit card limits on customer accounts, it is possible that these consumers are now finding their credit scores dropping as well.  In a recent FICO score study, the company found that that approximately 20 percent of the U.S. population experienced a reduction in total revolving credit between October 2008 and April 2009.  In general big reductions in credit limits will work the same as increases in the debt by reducing the amount of available credit and subsequently result in a negative impact on a credit score.

According to data from FICO score, the scores derived assess a lot of data and the effect of a single factor like a credit limit reduction on an individual credit score will depend on what other data is on the credit report and how much the credit card limit or line is reduced.

The key factors that impact the credit score in conjunction with a credit limit reduction, according to the folks at FICO score, include:  the amount by which their credit limit is reduced, what actions are taken by the consumers in reaction to the reduced credit limit, such as, late monthly payments, changes in the account balances, or opening a new accounts, as well as any other changes in the individuals credit report after the credit limit is reduced.

The negative impact of the reduced credit limit is therefore substantially mitigated by either positive steps of the consumer such as reducing credit balances or financial missteps such as late payments.  A credit limit reduction on a single credit card account won’t necessarily damage someone’s credit history or credit score.  The final impact will vary depending on each person’s unique credit profile.