Why Was My Credit Limit Lowered?

Jennifer writes in:

Yesterday, I received a notice from [my credit card company] that my credit limit had been lowered from $10,000 to $4,000 on my primary credit card. I was immediately worried that my credit had been damaged by identity theft, so I checked it on annualcreditreport.com and there was nothing there at all. I’ve always paid all of my bills on time and my life has been pretty much normal and unchanged for a long time. Why would they make this change? I’m not concerned about reaching my credit limit, but that reduction in my limit does alter my debt-to-credit ratio, which could negatively impact my credit rating.

Jennifer describes a pretty typical scenario today. A credit card company sends a letter out of nowhere, for no obvious reason, announcing a significant drop in one’s credit limit.

One big effect that such a drop has is that it alters your debt-to-credit ratio, as Jennifer mentions. Simply put, your debt-to-credit ratio tells what percentage of your credit limit across all of your credit cards you’re actually using. So, let’s say Jennifer had a $3,000 balance on her $10,000 card – that’s a 30% debt-to-credit ratio. When the company drops her credit limit, she then had a $3,000 balance on a $4,000 card – that’s a 75% debt-to-credit ratio. The higher your debt-to-credit ratio, the more negative impact it has on your credit score.

This type of behavior seems alien, particularly after a decade where credit card issuers would commonly raise credit limits without you even asking. What gives?

The reality of the credit card industry has changed. For one, the econmic downturn has seen a large spike in the number of people who have simply defaulted on their credit card bills, not bothering to pay them. For another, the Credit Cardholders’ Bill of Right Act recently became the law of the land, restricting some of the business practices of the credit card companies.

Credit limits are not a right. Another issue is that many people, particularly after the last decade of rampant growth in credit limits, view their limits as something of a right and when credit card companies reduce those limits, their rights are somehow being infringed. In truth, that’s not the case at all – your cardholder agreement makes it very clear that your credit limit and your interest rate can be changed at any time.

So how do they decide when to lower your limit?

They watch what you buy via data mining. Every time you make a credit card purchase, the credit card issuer’s computers store a record of that purchase (you’ll see such information on your bill). Obviously, this is a wealth of information, one that they can use to figure out all sorts of things, such as where you live (so that if you suddenly make a rash of purchases elsewhere, they can throw a block on the card).

They draw conclusions based on what you buy. Another thing that they do is watch what you buy. They look at the places you normally shop and draw conclusions based on that.

Let’s say Jennifer normally shops for clothing at, say, Banana Republic (I don’t know this, I’m just creating a hypothetical example). Based on this, the credit card company would conclude that she fits the profile of an average Banana Republic customer, meaning she has a fair amount of discretionary income.

Now, let’s say Jennifer is suddenly a bit worried about the economy. She and her husband decide to curb their spending and she starts doing things like buying soap at the dollar store with her credit card.

When the credit card company analyzes the data, looking for spending changes that might affect credit limits, they’ll observe from their data that Jennifer is spending a lot less at the Banana Republic and a lot more at the dollar store. That means she’s got a different spending profile – one that signifies the potential for financial trouble.

They act in accordance to those conclusions. Given their recent problems with people defaulting on credit card debt, they take pre-emptive action and reduce her credit limit.

To Jennifer, this seems sudden and unfair – and for good reason. She’s likely not in any true financial trouble at all and is simply choosing to be a bit thrifty in these uncertain times.

What can you do to protect yourself? The truth is that Jennifer should avoid being in any kind of position where such a credit limit change has any impact at all on her. In other words, don’t be reliant on that piece of plastic. Use it as a tool instead of as something you need to have. There are, however, a few things you can do when your credit limit is unexpectedly lowered.

One big way to do that is to never carry a balance on your card. If a bill comes at the end of the month, pay it off. If you’re thinking of making a purchase where you wouldn’t be able to do that, you can’t afford that purchase. Wait a few months and save up the cash.

This not only keeps your debt-to-credit ratio pretty low, but it also leaves you out of any sort of “danger” from the credit card company adjusting your limits or your interest rates. More importantly, though, it prevents you from building up a significant amount of debt on the card, which can be very, very difficult to pay off.

Use your credit cards wisely and changes like what happened to Jennifer will have little or no impact on your life.

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23 thoughts on “Why Was My Credit Limit Lowered?

  1. Becky says:

    Trent implies that paying her statement in full every month would put Jennifer in a position where the credit limit change wouldn’t impact her, which is misleading. Any amount you charge on a card, paid off in full at the end or not, is shown as your balance on the card to the credit reporting agencies. If Jennifer normally puts $1000 on her card and then pays it off at the end of the month, the impact of her limit being lowered from $10,000 to $4,000 would be that her reported debt to credit ratio would change from 10% to 25%.

    To truly have little/no impact on her credit score Jenifer would need to start charging less on her card or start paying half her bill twice a month so the amount shown that she owed would be half of what she spent that month. I think Trent has a post to that effect somewhere, but I thought it should be mentioned here.

  2. cendare says:

    Jennifer should also be told that this (lowering credit limits) is happening industry-wide. A March 5 story in the Washington Post said that it happened to 13% of the people they surveyed. It happened to me too (I’m a “charge and pay it off the same month” person). So, you know, it’s not personal. Trent still has some good advice on how to minimize the effect.

  3. Credit says:

    Becky is correct. Many times the credit card companies report a the balance before or right after the statement is due. The only way to ensure you don’t go over 10% utilization, which has been shown to reduce credit score is to have a lot more available credit or to just only spend $400/month on the card.

    I like that you highlighted the spending pattern recognition. It’s important and most people do not know they’re being watched with such a close eye. Increases in the frequency of Walmart shopping or auto repairs could signal the same alarms for their risk models as a decrease in FICO score.

  4. Ryan says:

    Going along with how they monitor spending patterns, I’ve heard that you if you use a credit card to buy a tank of gas, then a pair of tennis shoes, and finally another tank of gas, there’s a good chance the card company will think your card has been stolen.

    Apparently, when most people (teens I’m guessing) steal a card, they buy gas for themselves and a friend and get a new pair of Nike’s.

  5. Kevin says:

    “Obviously, this is a wealth of information, one that they can use to figure out all sorts of things, such as where you live…”

    Uh, I think the credit card company already knows where you live.

  6. Moby Homemaker says:

    This happened to me my limits went from $25,000 to under $5000 with one e-mail….on cards that I’ve never had any deliquencies, etc. I realize that limits aren’t a “right”–but that’s bad f’ing business and a crappy way to treat the GOOD customers.(Yeah, I’m talkin’ to you Shmaerican Shmexpress).

    Thanks again for the info, Trent.

  7. Vanessa says:

    I know that Trent said “where you live” but I think what he meant was “where you go.” I live in one city, but travel weekly between two and often visit another. The credit card knows this because of my spending patterns. I have occasionally traveled much further, and when that happened I got a phone call from the company letting me know that my card was being used in X city and making sure that it hadn’t been stolen.

  8. Michelle says:

    It’s not just spending patterns either. With one card, I’ve been paying down my balance, paying more than the minimum on time, and I haven’t used the card in over a year. I’ve had my limit lowered twice in the last year.

    The irony? They lowered my limit because my debt ratio was too high…

  9. Lisa says:

    Use’m each month to collect points towards gift cards ect and pay off each month. I could care less about the credit limit as I would just switch to a debit card or cash. Oh also use’m to dispute charges. The point is Use Them do not let them Use You.

  10. Kai says:

    What if you use a significant portion of the card, AND pay it off every month? Then the lowering of your limit either lets you use a lot less money, or makes you look less responsible due to the change in ratio. This affects even a person who uses credit cards wisely.

    I know many people who have cards for business expenses – when they go away, they put all trip expenses on the card, and are reimbursed by the company before they have to pay off the card. It’s a wonderfully convenient and responsible system – that will not work when the limit is lowered.

    Yes, they can lower the limit at will. But it’s not exactly customer-friendly to do so.

  11. prodgod says:

    @Molly on Money: CASH is cumbersome, risky, inconvenient, and hard to track. Checks are almost as much of a pain. My personal preference is plastic.

  12. Mule Skinner says:

    When the cards begin to mistreat me I will abandon them in a flash.

  13. Shevy says:

    I’ve had both reductions and increases in my limits over the past year or two! And I’ve had my interest rate reduced at least twice on the card that increased my limit by $3K! The card that reduced the limit was Home Depot, where we regularly buy reno supplies on either 6 month or 12 month 0% interest payment plans and we’ve always paid the plan out just before its due date. We needed it raised again when we bought our storage shed (they’d dropped it from $2,000 to $600 without us realizing it) and it took 5 minutes or so on the phone for them to put it (most of the way) back up.

    I’ve kind of given up trying to figure it all out….

  14. Becky says:

    The problem with our situation is when the credit limit is too low to provide what we need. For example…plane tickets for our whole family. If they cost 5K and we have only a 4K card, we need to either have already sent in extra to the cc company or buy them in separate bunches with time in between to pay the difference. This is really inconvenient!

  15. Jacinta says:

    “Use your credit cards wisely and changes like what happened to Jennifer will have little or no impact on your life.”

    This is a naive view. It might be true for many people, but I would not presume to suggest its true for all or even the majority of readers of the blog. Readers of this blog probably already know about using credit cards wisely and may already have the lowest limit on their cards they can work with.

    My credit limit is $8k and I put about 95% of my purchases on my credit card and pay it off in full every month ($2.5k-$3k). I also do a lot of travel, which I usually pay for in full and get reimbursed by my self-owned company quarterly.

    At least once a year, but up to three times a year, I’ll hit or get very close to my $8k limit. For example, if I’ve just purchased an international return trip for two, internal flights, accommodation and event tickets.

    If my bank were to reduce my limit, it would certainly *not* have “little or no impact on my life”. It would be a big deal. First I’d call the bank and ask them to reconsider. If they refused, I would close all my personal and business accounts with that bank and move to another bank that wanted my business. My credit limit may not be a right, but in my opinion, it’s part of the agreement I’ve made with the bank. A smaller credit limit than $8k won’t work for me.

  16. de Ruiter says:

    #16 Jacinta, Get another credit card so you have two cards, pay for part of the package with one card and the rest of the balance with the other. Paying online twice a month keeps the amount charged on a card low, it helps you keep an eye on your expenses and you’d spot any bogus charges faster. My experience is that if I need extra credi for something like an expensive trip, or buying a car, I call the credit card company, ask for an increase which is temporary, get the increase, buy the item, pocket the frequent flyer miles, and ask the company to put the lower amount of credit back. I’ve never been refused, because the company wants that extra hunk of business.

  17. Des says:

    Tracking where you spend your money is by no means the only reason card companies are lowering the limits on good customers. A bigger reason is they are tightening up their lending guidelines. You no longer fall within the lending guidelines for the $10,000 limit based on information they glean from regularly checking your credit report. Not everything is a conspiracy.

  18. Lily says:

    Trent,

    This article and the comments above are very helpful. I learned a lot!

    Thanks.

  19. Geoff Hart says:

    It’s also true that a lot of these changes are fully automated (i.e., generated entirely by a computer program), with no human oversight. So just because your credit limit changes, that doesn’t mean you have no say in the matter. Often, calling the card issuer and requesting a change will get the increase or decrease you ask for. Whether that’s a good thing depends on whether you’re able to avoid incurring debt beyond your ability to repay.

  20. Mary says:

    I always thought that if you had a high credit limit, say $25,000.00, even if you only put say $1000 on a credit card, any business looking at your report would see you have 25 thou available every month & hold that against you. Even if you don’t use the credit. Because you COULD. Am I wrong?

  21. Steve in W MA says:

    @ Mary,

    That mainly applies to mortgage lenders and banks who are reviewing your finances after you apply for a loan with them. If you’re going to be applying for a mortgage or a bank loan then having a high combined credit card limit can be a problem if your income doesn’t support the limit in the bank’s view.

    Otherwise, there’s no need to worry about having a high credit card limit.

  22. denny s says:

    I have managed to save a bit of money which I use as my “line of credit” Any money taken from it becomes a bill to pay, just like a visa or amex. In addition to these payments, I add a minimum of $100 a month, so my “credit line” is always increasing. No, it does not help my credit score, but neither do I have to worry about unexpected credit limit cuts or even worse, a credit card being cancelled. Just an idea, it works for me.

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