Vision Credit Education, Inc.

Major credit card companies have begun lowering credit limits for many of their cardholders as a way to reduce their exposure to potential losses. As a result of these credit limit reductions, your credit scores can deteriorate to the point that other creditors take notice and act in an unfavorable way.

Major Component of 30% of Credit Score Calculation

Thirty percent of the credit score formula is based on your debt balances. While higher debt balances can cause lower credit scores, a bigger factor is the percentage of your total credit limits that you are using.

Credit scores depend heavily on your credit utilization rate, which is a calculationn that shows how much of your available credit you are actually using. For example, if you have a $4,000 balance on a credit card with a $10,000 limit, then your utilization rate is 40%.

Credit Scores Drop as Utilization Rates Exceed 10%

Many financial experts frequently cite a 30% credit utilization rate as a threshold that you do not want to exceed. In all reality, any time your credit utilization rate exceeds 10%, your score will begin to drop.

According to Fair Isaac spokesperson Craig Watts, this occurs based on a sliding scale. In other words, the higher the credit utilization rate, the more it affects your credit scores negatively.

This is primarily the case for revolving lines of credit, such as credit cards or unsecured lines of credit at your bank. A similar penalty can apply to secured debts that you are repaying according to an installment plan. The impact on your credit is less severe in those cases since it is expected that you owe nearly the entire amount on a new installment loan.

Credit utiliization rates affect your credit scores on an individual level as well as collectively. A high credit utilization rate on a single card can adversely affect your credit scores. Your average credit utilization rate also has an impact.

Lower Credit Limits Increases Utilization Rates

If you have a $4,000 balance on a credit card with a $10,000 credit limit, your utilization is in a state of caution. If your creditor lowers your credit limit to $5,000 on that card, then your utilization rate has just soared to 80% for that card. Your overall utilization will also increase at a rate that depends on your other lines of credit.

A reduction in your credit limit on one card can cause a domino effect where other creditors also follow suit. This can cause your credit score to further erode, costing you new credit opportunities and likely interfering with other non-loan events such as landlord, employer or insurance credit checks.

Opting Out of Term Changes

The credit utilization rate can also rise dramatically if you opt out of changes from your credit card issuer. Such a move requires that the card change to an inactive status. This can cause a tremendous increase in your utilization rate and a subsequent drop in your credit scores.

Protect Yourself

There are a couple of ways you can protect yourself. One is to begin increasing your monthly payments toward your revolving debt accounts. This can cause your utilization rates to drop and show the type of financial strength that is often rewarded through increases in your credit limits.

Also, if your limits have dropped to the point that you are maxed out on several accounts, you might want to consider getting help through credit counseling. A utilization above 75% reflects a possible crisis situation. A debt management plan might provide the lower payments and reduced interest that can help you more quickly lower your debt balances, thereby restoring your financial situation and your credit rating.