Credit Card Double Whammy

Credit card companies, like most of those in the world of banking and finance, are feeling the pinch of the current credit crunch. They are seeing higher default rates, and they feel the need to manage the risk of further, even higher, defaults. One of the ways they do that is to raise interest rates. That may already have happened to you. Another way to manage risk is to lower your credit limit. The problem is that can also lower your credit score.

AP explains it this way:

Let’s say a cardholder has a credit limit of $10,000 and a balance on the card of $4,000. The card company worries that large balance may increase the prospects for default, so it lowers the credit line to $5,000. But in doing that, it completely changes what is known as the credit utilization rate, raising it from 40 percent to 80 percent. That is then factored into the calculation of one’s so-called FICO credit score, which measures creditworthiness, according to Craig Watts, a spokesman for FICO-creator Fair Isaac Corp.

Just like increasing your interest rate, a credit card company can lower your credit limit even if you’ve never missed a payment, and you may not even know it until you apply for credit and discover a drop in your credit score. Monitor your statements and your credit reports, so you’ll be prepared. If it happens to you, and you have a specific need to protect your credit score (you’re buying a home or a car, for example) you might try asking the credit card company to increase the limit again. Long term, the answer is nothing startling–try to pay your cards down as much as, and as quickly as you can. And if the increased interest rate, increased monthly payments, and lower credit scores have made it impossible to pay them off over a reasonable period of time, you may need to look at other options.