The effect of reducing your credit card limit depends on how much debt you have and how you use your credit cards. In some cases, your credit score will drop when you reduce the limit on a credit card. However, there are other situations in which a reduced limit will have no effect on your score or will help you increase your score by managing debt more effectively.
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Credit Utilization Ratio
About 30 per cent of your credit score is based on the amounts you owe on all of your credit accounts. Part of this portion of the score looks at your credit utilisation ratio, which is the proportion of your credit that you use compared to your credit limits. When you reduce your credit card limit, this can change both your utilisation ratio on that card and your utilisation ratio across all accounts. According to MSN Money, you should try to keep each utilisation ratio under 30 per cent to avoid hurting your credit score.
For example, say you have only one credit card with a balance of £1,300 and a limit of £5,850. Your utilisation ratio is about 22 per cent, which is within the target range. If your reduce your credit limit to £2,600, your utilisation ratio suddenly jumps to 50 per cent, which is likely to hurt your credit score. On the other hand, if your balance on the card was only £325, your ratio would only increase from 6 per cent to 13 per cent. Because both of these numbers are good ratios, you probably would not see an effect on your credit score.
If you carry debt on your credit cards, avoid hurting your credit score by keeping your limits high, if possible. However, your credit card company can cut your limit without your approval. If this happens, you can use one of two solutions to repair your credit score. The first is to pay down your credit card balance. For example, if you have £1,300 of debt on a card with a new limit of only £2,600, you can cut your utilisation ratio to 30 per cent by paying off £520, leaving just £780 on the card. The other option is to call your credit card company and ask for a credit limit increase. If you do not succeed the first time, call again every few months.
If you spend money on a credit card just because you have a high credit limit, you can actually help your credit score by reducing your credit limit. This is because the lower limit can keep your debt manageable so you can keep up with payments. Missed payments and collection accounts can do more damage than a high utilisation ratio. For example, if you just consolidated credit card debt with a home equity loan and are worried that you might overspend on the cards again, cut their limits to keep your spending low and control the monthly payment amount.
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