Reduced Credit Limit Means Lower FICO Score

In this recession, many consumers find their credit as the credit crunch continue to take its toll. Banks and credit-card companies hit by charge-offs are tightening up their lending standards.

Fair Isaac Corp., the developer of the FICO score. estimates that at least 30 million Americans had their credit limits reduced during the second half of 2008. In the first quarter, New York-based JPMorgan and Citigroup Inc. and Bank of America Corp. in Charlotte, N.C., slashed $320 billion from credit lines, according to a report by former Oppenheimer & Co. analyst Meredith Whitney.

More recently, May 4’s quarterly survey by the Federal Reserve Bank showed about 65 percent of banks lowered credit limits on new or existing credit-card customers, compared with 45 percent in the January survey.

The FICO score evaluates your total balances in relation to your available credit. A full 30% of your FICO credit scores depend on factors that directly depend on your credit balances. Your credit utilization rate is a calculation that shows the percentage of your revolving credit that you have used. A card with a $10,000 credit limit and a $4,000 balance has a 40% utilization rate. If that lender drops your credit limit to $7,000, then your utilization rate just jumped to over 57%. The more debt you have, the more your scores may drop.

As banks reduce credit lines regardless of individual risk profiles, people like Rep. Luis Gutierrez, an Illinois Democrat, are taking notice.

“Reductions to a consumer’s line of credit based upon the lending institutions’ overall appetite for risk has little or no bearing on a consumer’s own risk of default,” said Gutierrez, who chairs the House Subcommittee on Financial Institutions and Consumer Credit and is planning a hearing on credit scores before the end of the year, reported Bloomberg News.

However, FICO Chief Executive Officer Mark Greene told Bloomberg defending the scoring model: “FICO scores have held up quite well in terms of predictive accuracy. The bank’s action may signal a riskier environment and the view that you are a riskier consumer.”

The FICO 08 system, introduced in May 2007, refines previous models by limiting the effect of authorized users who artificially increase scores and separating chronic late payers from consumers who have isolated late payments.

Borrowers who have higher utilization rates will receive fewer points. Credit cards that are "maxed out" can lower your score. Consumers are advised to pay more each month and spend less than 30% of your credit limit.

If you desperately need to counterattack against your lowered credit score, you may try to transfer the balance to an open line on another credit card with a higher limit. This will improve your credit utilization ratio in the eyes of FICO.

(July 8, 2009)