Monday, 9 Mar 2009

Credit Card Limits Getting Slashed

This article is a guest contribution from Steve Sildon at Steve writes frequently about credit cards, providing tips and expert advice on a variety of personal finance and credit-related topics as well.

In 2008, many credit card holders were shocked to find their credit limits getting slashed so dramatically and that trend has only continued into 2009. There is a variety of reasons why credit limits have been getting reduced, including account inactivity but also because of changes to the credit risk profiles of so many cardholders that have changed as the direct result of the dramatic downturn in the economy.

Cards that have remained inactive for long periods of time were the first to go. Michael Riley, a software engineer from Denver and a long time customer of J.P. Morgan Chase, just received his second cancellation notice. “I just got a notice from Chase last week that my platinum card was being closed because of inactivity.” Riley hadn’t used the card for over a year but was miffed at the thought of losing an account that he had held for so long. “That was one of the first credit cards that I ever got right after college.” Many cardholders have shrugged off these account closures because most people don’t believe they will be affected by a card that they never use. Out of sight, out of mind, right? But another problem has emerged from these account closures that many people are unaware of.

These sudden account closures are also negatively affecting FICO scores for countless numbers of cardholders. FICO scores are computed utilizing several factors, including payment history, credit utilization, new credit accounts, types of credit being used, as well as the length of the credit histories. When an account is closed, it can dramatically affect the credit utilization score of a user. For instance, a cardholder with a $5,000 card balance on a $12,000 card limit and a zero balance on a $13,000 card limit has a total credit utilization ratio of 20%. But if the card issuer decides to close the account with the $13,000 limit because of “account inactivity”, that cardholder’s utilization ratio will jump up to 40% – in an instant. Credit utilization accounts for roughly 30% of the total FICO score so a jump in utilization from 20% to 40% can have a devastating impact on a credit score in a very short period of time.

“My credit score went from 785 to 668 in less than 90 days and I’ve never been late with a payment,” said Craig Woodside, a plumbing contractor in Trenton, New Jersey. “The only thing that changed in those 90 days was Citibank closing one of my old credit card accounts.” Another credit scoring factor that is negatively impacted by an account closure is the length of your credit history. Cardholders with accounts they have held since college, which are being closed for inactivity, wind up losing the entire credit history on that account. Some cardholders have had accounts closed with more than 20 years of credit history. With length of credit history accounting for about 15% of a total FICO score, these types of account closures, seemingly harmless at first glance, are really hurting people’s credit scores in a big way.

So, faced with the prospect of a drastic drop in credit scores, what can you do about this particular problem?

There are a few things that you can be proactive about in order to keep your account off of a card issuer’s chopping block. First, make sure that you maintain activity on the card, even if it’s just the bare minimum. You might consider setting up an auto-payment with the card for a utility bill, magazine or newspaper subscription that you know you’re going to have to pay each and every month. You don’t have to go out and overspend frivolously with the card (like so many people do with their rewards cards) – just keep the card active.

Next, make a preemptive call to your card issuer. Be sure to indicate your desire to maintain the account and ask if there’s anything that you need to be aware of (besides making your payments on time) or other things that you should be doing to keep your account in good standing. Make sure that the customer service representative notates your desire to keep the account in your file and be sure to indicate to the representative that you will maintain activity on the card.

And finally, if you haven’t started paying down those card balances just yet, now is the time to do it. Cardholders should aim for a credit utilization ratio of no greater than 30% on any individual card and in total. Paying down those card balances aggressively and driving your utilization ratios downward will have a significantly positive effect on your credit score in a short amount of time.

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