Lower Debt to Credit Ratio vs. Possible Slashing of Credit Limit

A reader sent me an email about a situation that they noticed lately…

I have known several people lately who have been working toward paying their credit card balances down. They’ve been rewarded for this by having their limits slashed and interest rates dramatically increased – both of which have had a huge negative impact on their credit score (debt-to-credit ratio).

I’ve been hearing more about credit card companies giving those unpleasant gifts to people who didn’t do anything wrong. They didn’t pay late. In fact, some are paying more than the minimum payment to try to pay off their debt and some have high credit scores.

The reader was wondering if anyone is taking the above situation into consideration when paying off their debt – especially if you are looking to get a mortgage soon. You can pay off your debt and lower your debt to credit ratio – but you may find yourself a lower FICO score if your credit limit is slashed.

It’s a tough situation. There is no guarantee that your credit card company will be one of the “bad” ones. But if you pay off your debt you are guaranteed to look better to lenders. I completely understand being hesitant on this (it was tough for us to get a small mortgage with all of our debt). I don’t know for sure, but perhaps if you pay off debt and your limit is reduced, maybe you can bring proof of that change to the lender and maybe they’ll take that into consideration?

Anyone have more thoughts about this?

Posted by Tricia on March 17, 2009 at 10:16 PM in General Personal Finance | 13 Comments »
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Debt-free Dan responded:
Posted: March 17th, 2009 at 11:28 pm
Unfortunately, if you borrow their money you have to play by their rules. I’m sure what they’re doing is permitted by the terms and conditions agreed to by the borrower. In reality, they have some ability to manipulate your credit score by lowering your limit or if their increased rates or any fees causes an increase in the balance, then it incrementally damages your credit score.

The reality is the company is not offering a public service. In these economic times, they make more money by charging you more. Their self-interest is at odds with the borrower’s. If you don’t need to borrow money, then your credit score doesn’t matter.

Credit cards are like a car dealer that can’t make any money selling you a car for cash. This is an adversarial business model and the only way you can win the game is not to play.

So get out of debt fast and never borrow money again. The borrower IS slave to the lender.

Debt-free since 2007!
Evan Powell responded:
Posted: March 18th, 2009 at 12:19 am
Chase and Bank of America have done this to me.

After every thousand or two I pay off on BoA I get a letter in the mail letting me know my limit has been decreased. They also increased my rate from 7 to 22. I’ve called them and agreed not to charge anything else to the card. They’ve agreed to bring the rate back down to 7.

Chase just started this with me. I recently received a letter stating that they too will be lowering limit and increasing rate. I’m going to call them and reason with them. I’m pretty sure since I’ve always paid on time that they will bring the rate back down but I will probably have to agree not to use the card anymore and that is just fine with me.
moderntightwad responded:
Posted: March 18th, 2009 at 12:32 am
I really don’t know about this, but it has me nervous too. Mr. MT and I would like to buy a house before November, and it has me second guessing every move. I’m even afraid to take advantage of a 0% offer we received because I don’t know how it will effect our FICO score (particularly now that Equifax won’t tell me anything)! Luckily we’ve only seen one card (Capital One) raise an interest rate, and it didn’t effect anything because we have a locked-in rate on a balance transfer, for the life of the balance. Unfortunately, if a credit line is reduced I don’t think a lender will care about what was, only what is. I’m just hoping our luck holds.
Mr Plasectomy responded:
Posted: March 18th, 2009 at 4:47 am
More and more stories about this keep happening, I think it is only a matter of time before all of them jump on the bandwagon and do it to some of their customers.

If you were not paying that money towards paying down your balance then you would have that money to put down on your home. I care about my FICO score too and I want to be out of debt. I am willing to have my FICO score take a hit temporarily to have that peace of mind and not wondering what my credit card company might do.

My thoughts may be different as I have both a mortgage and auto loan to continue to build my credit history.
Nadia responded:
Posted: March 18th, 2009 at 8:36 am
The problem is that the CC companies are trying to repair the damage they have done to themselves over the last 6-10 years. They have extended so much credit that now it is catching up with them and some people can’t pay it back. Their trying to be proactive and revoke said credit to decrease their possible losses is unfortunately hurting people.

What are the FICO scores of those getting the shaft? Are they across the board, or is this isolated to the under 720 crowd? My guess would be this is happening to people under 720, since the FICO score is an effort to rate the likelihood that the person will repay any loans. Anyone have different experience? (anyone with 760+ FICO score and spotless credit history?)
Jay responded:
Posted: March 18th, 2009 at 10:06 am
I’ve been tempted to cancel my cards as they are paid off, but wanted to keep the available credit for the same reason. I’ve had Chase lower my limits and I’ve had US Bank raise my limit after paying off their card.

Once I pay off all the cards, I won’t worry about the limits because zero balance divided by any credit limit will still be 0. That’s the debt to credit ratio I’m looking for!
mapgirl responded:
Posted: March 18th, 2009 at 10:09 am
Hi Nadia!

My FICO score 6 mos ago was 696. It’s now 700 and I got a limit increase and a rate increase on one card. I called and I had the rate lowered back down. (10.99% to 16.99% to 11.242%)

I think the bigger question is timeliness of payments. Paying on time is 35% of a credit score. It’s heavily weighted under the assumption that people who are chronically late paying their bills are probably juggling their cash flow because there just isn’t enough to go around.

I’m not sure you can blanket say that ppl with one score or another are getting shafted. I suspect there is some behavioral analysis going on before companies do this, because if it was only score related, I’d probably have this problem too.

Just my two cents.
Kev responded:
Posted: March 18th, 2009 at 12:14 pm
I doubt the recent credit card changes are specifically targeting those who are in the process of reducing their debt. I believe it’s pretty much happening across the board.

My fiancee and I both have capital one cards and the interest rate was recently hiked up on both of them. Her credit score is in the high 700′s, where as mine is barely hitting 700. Neither of us are carrying a balance, so we could care less.

I don’t think anyone should limit their debt reduction efforts in an attempt to spare their FICO scores. The fact the cc companies are pulling this crap is enough reason alone to pay them off as fast as possible. A zero percent utilization on revolving credit lines will raise your FICO score anyways. There is no way to know if your card issuer is going to decrease your limit and/or increase your rate. They can do that whenever they want to without reason. The only way you can truly be safe is by paying it off – you’re literally dancing with the devil until then.
Sandy responded:
Posted: March 19th, 2009 at 11:46 am
@Nadia

I don’t think it matters what your credit score is. Mine is above 720 and so far, so good. My brother’s is above 760 and Citibank tried to raise his to 22%. No late payments and no missed payments. He was able to fight them off since he has both business and personal accounts with them and a significant amount of money in their bank.

Sure their terms say they can do it so right now I am prepared for the axe falling. I plan on transferring money to another card that I have kept at a zero balance if Chase does this to the card where I have a balance.

I think if you are buying a house you can make a case for a better rate if you have paid down your debt. That is where we should focus before adding a large debt like a house. It’s just the responsible way to do things in these times.
Karen responded:
Posted: March 19th, 2009 at 4:33 pm
My thought is we should all write our congressmen and start demanding that FICO score calculations be made public. FICO scores were developed after the credit bureaus were made to PROVE that their info was correct. They could no longer put the burden of proving the info INCORRECT on the consumer. So they came up with FICO. It is just another indicator of the total insanity of the entire system. The greed and loss of integrity of these companies makes me sick!!!!
Rini responded:
Posted: March 19th, 2009 at 5:21 pm
If you’re worried about it, just make your “extra payments” to a savings account instead. When you have enough money to pay the debt in full, do it. No worries about limits & your credit score.
Kevin responded:
Posted: March 20th, 2009 at 6:26 pm
Yeah. My inlaws just made $18k in payments to pay off two different Bank of America cards. As a thank you, B of A closed the accounts.

It sucks because on the advice of their financial planner, they did this because the planner said they could use these 2 cards as their emergency fund.
The Mommys Place responded:
Posted: March 26th, 2009 at 8:51 am
All of our credit cards have done the same, either increase rates or lower available credit. Our family has chosen in those cases to not charge anything on the card in order for the rates to stay the same. We have not been using any credit cards for over a year now, so this agreement with them is fine by us.

We are building our emergency fund and paying off the debt as we can. Once our emergency fund is funded we will start knocking those balances off one by one, till they are all gone.