You may think you're reducing your temptation to overspend by lowering your available credit. But that's not the only potential result to consider.
The following is a question I recently received from a Money Talks News reader:
I’ve been sort of awful in the past about running up balances on my credit cards. I’ve been getting better of late, and have actually paid down quite a bit of my existing debt. That said, I’m worried about falling back into old habits and was thinking about lowering my credit lines or even canceling old cards altogether. Good idea or bad idea? Thanks. — Mia S.
First off, it’s great to hear about readers like Mia paying down debt and thinking seriously about limiting their exposure to credit cards. Sometimes we need to protect ourselves from, well, ourselves. And lowering your credit — and closing old cards altogether — are certainly options to consider if you think your spending is in danger of getting out of hand.
Unfortunately, both strategies could have potentially adverse effects on your credit scores.
We wrote a few weeks back on the topic of closing old credit card accounts and how that could negatively impact your scores. To summarize, closing old accounts puts a cap on how long your accounts in good standing will show up on your credit reports, which limits the positive impacts they can have on your credit scores. It would also lower your total available credit, which in turn could increase your credit utilization ratio – the amounts you owe relative to your total available credit. MyFICO says, “So, by closing an old or unused card, you are essentially wiping away some of your available credit and thereby increasing your credit utilization ratio.”
As you may have guessed by now, the same rules apply when lowering your credit limits.
For consumers like Mia who carry a balance – be it a big balance or otherwise – lowering your available credit lines will definitely increase your credit utilization ratio. For example, if you owe $2,000 total in credit card debt, and you lower your total available credit line from $10,000 to $5,000, suddenly your credit utilization ratio jumps from an OK 20 percent to a more concerning 40 percent.
While FICO doesn’t say exactly what your credit utilization ratio should be, many credit experts recommend having a credit utilization ratio of no more than 30 percent and ideally less than 10 percent.
So as you can see, lowering your credit limit may not be the best course of action because of the potentially negative effects it can have on your credit score.
A better solution
If the temptation to spend is still there, but you’re unwilling to lower your credit line because of the harm it can do to your scores, here’s what I would recommend: Sock drawer your cards or put them in your freezer (a literal spending freeze, if you will) to remove the physical temptation to spend.
Then remove the cards from your online shopping accounts, again to avoid temptation. And finally, set up automatic bill pay with your credit cards for your utility bills or phone bill (and we can even recommend a card that will pay you cash back on utility expenses) so that there’s still activity on your cards. Just be sure to note if there’s an additional charge to pay with credit, in which case we would recommend linking the bill with your checking account.
Why all of this? Because it limits the balance you can rack up with your cards while maintaining activity on the accounts.
Credit card issuers reserve the right to close your account after extended inactivity and, as we mentioned above, that can have precisely the effect on your credit that you’re hoping to avoid. Using your cards for the expenditures you need to make each month anyway is a good way to keep them active without overspending.
There are other strategies consumers like Mia can use to resist the urge to spend while maintaining and improving their credit scores. Lowering your credit line may limit the amount of debt you can rack up, but it could also lower your scores and hurt your chances at loan approval in the future.
Keep your credit lines where they are and – if necessary — put physical barriers between you and your credit cards to keep that balance from going up. Prioritize paying down your debt and use your credit cards only for the expenses you need to make each month.
In the end, improving your willpower will end up improving your credit scores, too.