LIMIT REDUCTIONS/Closing and opening credit and it’s impact on scores!

I have written an article on this topic before but it seems to be confusing and shocking to consumers and professionals alike.

It was over a year ago when we started to hear about American Express reducing limits or shutting down credit cards on consumers. American Express was the first creditor to take an aggressive stance on protecting themselves from credit card defaults at the consumers expense.

I remember having a client who owned a business and used his American Express card to juggle expenses while waiting for receivables to arrive. He was trying to take out financing on a $1,000,000.00 + piece of property that he owned outright. He needed 20 points on his score and had a high balance on his card. Paying his American Express balance down to $20,000.00, which was 30% of his limit, was the quickest way to reach his goal.

The day after he paid the balance down American Express reduced the limit to $20,000.00 and we were all surprised and obviously very upset since his score dropped 70 points. This took him further away from his goal.

It is important to understand the creditor’s are looking for ways to reduce their risk factor on future defaults.

Even if a consumer has NO late payments or negative information on the credit profile, if they carry balances over 50% of the limits this is a red flag for the creditor that the potential to default is there. If you have $50,000.00 of debt and your limits are $80,000.00 you can see how a creditor would be thinking of the potential risk in a bad economy.

Most creditors wait until balances have been reduced to cut the limit. They are afraid to cut limits when there is a high balance since the credit card holder has a greater incentive to stop paying completely. There are those creditors who reduce the limit or even close the account when the balances are high.

This can be devastating to the credit score. First just by closing the account the score can drop 60 points. Second by reducing the limit to less than the balance the score will plummet. When balances are over the limit (even if the balance is $1.00 over) it is a red flag to the scoring systems that this consumer is a high risk and the score is driven down dramatically.

Credit Card Companies are preparing for the July 2010 rule changes that will force them to charge less interest to consumers and wait longer to increase interest rates on those with late payments. Creditors negotiated to have a period of time to prepare for these changes and have used that time to hike up interest rates on existing card holders before they were no longer allowed. Many have received letters from creditors giving an option to “Opt Out” and continue paying the current rate on the open balance.

This means the card will be closed as soon as the consumer opts out. If the consumer accepts the new higher interest rate the card will continue to stay active. This is putting the consumer in between a rock and a hard place.

If the card is closed it will hurt the credit score but if the interest is raised the cost could be significant depending on the current balance. In this situation I would pay off the balance (if possible) and keep the card active just to help my credit score. You can always charge a small amount of money once a year and pay it off just to keep the card from closing.

The card should not be closed just because you are mad the creditor is giving you this ultimatum. Think of your credit health first (the creditor is) unless you are having financial difficulty. For those who are having problems making minimum payments on open balances please see my article about “Bankruptcy, Debt Negotiation, and other choices” from November 2nd in the Newsletter section of our website.

We are hearing the frustration many have from seeing their credit limits reduced and credit cards closed with no history of defaults or late payment. Consumers feel that they are being punished for no reason. It is important to keep balances low if you want to protect your limits from decreasing. My opinion is to have no more than 30% of balance to limit ratio.

When it comes to opening and closing accounts consumers have a difficult time taking in the fact that this could cause significant decreases in the credit scores. It does not matter if the consumer or the credit grantor closes the account. The affects of closing credit are negative no matter how it is closed.

The higher your score the more it drops when this occurs. The most we have seen the score drop from closing or opening an account is 60 points. If many accounts are closed and opened around the same time the score will drop more but not the full 60 points for each event. The score drop can remain for up to a year. If the consumer has little variety of credit the drop can last much longer (see article in Newsletter section of our website about “Your Portfolio of Credit”).

Credit is considered “seasoned” after it has over 2 years of history. Statistics show that when consumers open and close credit the risk of default increases. This is why the score drops when these events occur. Make sure you time the opening and closing of credit with the events in your life that make sense. if you are not going for financing for a year or two that could be a good time to open more credit and build your credit portfolio or close accounts you no longer want.

“Great credit brings great opportunity!!”



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