A Lower Credit Limit Means a Lower FICO Score

Because of the global economic meltdown affecting the credit industry very hard, credit users are bearing the brunt of the credit crunch, leading to credit card debts reaching their all-time high. In turn, credit card companies are also tightening up everything that they can, including their lending standards.

Fair Isaac Corporation, the enterprise behind the FICO score, gives the estimate of more than 30 million Americans reducing their credit limit – and this is just for the 2nd half of 2008. Statistics show that for the 1st quarter of this year, big companies, such as JPMorgan, Citigroup Inc., and Bank of America Corp. reduced a total of $320 billion from the credit lines of their users. A more recent survey conducted in the first week of May 2009 shows that 65% of today’s banks show lowered credit limits – both with the new and the existing customers. This is quite a high figure, compared to just 45% in the January 2009 survey.

The purpose of the FICO score is actually to evaluate the relationship between your total credit balance and your available credit. If you compartmentalize your FICO score, 30% of this would be dependent on your credit balances. The credit utilization rate, on the other hand, would be the percentage of the revolving credit amount that you have already used. For instance, you have a credit card that has a credit limit of $10,000, and you’ve already used up a balance of $4,000 that has a utilization rate of 40%. If your lender decides to drop your credit limit to just $7,000, your utilization rate would jump to more than 57%. From this point of view, the higher your debt, the lower your score would drop.

Many politicians have already noticed this trend and a lot are saying that banks are reducing credit lines without much regard for the credit users’ risk profiles. The FICO scoring system is also taking quite a hit due to these reductions of credit lines.

Mark Greene, the CEO of FICO, issued a statement in defense of the scoring model. Greene states that FICO scores have consistently held up very well when it comes to predictive accuracy. The actions of banks today just indicate that the credit environment has become riskier and that the reduction of the credit limit of a particular account would likewise indicate that the credit user is considered a risk as well.

If your credit limit has been reduced and you need to improve your credit score, then it would be wise to transfer your remaining balance to another credit card that offers a higher limit. This way, your credit utilization ratio would significantly improve.