Would Lowering Your Credit Limit Lower Your Credit Score?

Many credit card companies are lowering their borrowers' credit limits to reflect the recessionary economy. Borrowers often are surprised by this, and many find out the hard way when they try to charge something. More important than the inconvenience is the impact a lowered credit limit can have on your credit report and score. Understanding how credit reports work can help you minimize the impact on your credit score.

The Effect of a Lower Credit Limit

While the precise formula for calculating a credit score has never been made public, nearly one-third of the score is based on how much debt you have compared to how much credit you have available. The wider the gap between your debt and your credit limit, the higher your credit score will be. For example, if you have a credit card balance of $750 and a credit limit of $3,000, you are only using a small portion of the credit available to you -- 25 percent. This is viewed favorably when determining credit risk, and, therefore, it boosts your credit score. If, however, you have a $5,000 credit limit and you have maxed out your card by using all the available credit, this will seriously harm your credit score. Therefore, having your credit limit lowered can have a negative impact on your score, because the percentage of available credit used will be higher.

Minimizing the Impact

If your credit limit has been reduced, you should try to reduce your credit balances by the same percentage as your limit reduction. This keeps your debt-to-credit ratio roughly the same and should minimize the impact on your credit score. If you do not have the money to pay down the debt, try to have the credit limit raised on another of your revolving credit lines. The impact is measured in totality (the debt-to-credit ratio of all your accounts combined), so it does not matter where the extra credit room comes from.

Closing Your Credit Account

If your credit limit is lowered, you may be tempted to close your credit card account. This will damage your credit score further, however. Credit scores favor those who have a lot of available credit and are using it wisely. By closing an account you are essentially dropping your credit limit in that account to zero. You should try to pay down your credit card balance quickly, but also try to use the account at least once a month to make a purchase to keep it active in the eyes of the credit bureaus.

Protecting Yourself from Credit Tightening

Monitor your credit accounts every month to ensure that your credit limit was not lowered without proper notification. By law, credit card companies must notify you by mail of a change in your credit limit. Review your credit limit on your statement and watch for changes. Also, make your payments on time to minimize the chance your credit limit will be reduced.