Welcome to the “2-Minute Money Manager,” a short video feature answering money questions submitted by readers and viewers.
Today’s question is about credit scores; specifically, whether lowering your credit limit could hurt your credit score.
Watch the following video, and you’ll pick up some valuable info. Or, if you prefer, scroll down to read the full transcript and find out what I said.
You also can learn how to send in a question of your own below.
For more information, check out “7 Ways to Boost Your Credit Score Fast” and “How I Got a Perfect Credit Score in 4 Steps” You can also go to the search at the top of this page, put in the words “mortgage” or “credit union” and find plenty of information on just about everything relating to this topic.
Got a question of your own to ask? Scroll down past the transcript.
Don’t want to watch? Here’s what I said in the video
Hello, and welcome to your “2-Minute Money Manager.” I’m your host, Stacy Johnson, and this answer is brought to you by Money Talks News, serving up the best in personal finance news and advice since 1991.
Today’s question comes from Felicia:
“I recently paid off a credit card with a limit of $10,000, and asked the credit card company to lower my limit to $2,000. Will this hurt my FICO score?”
OK, Felicia, let’s discuss.
The short answer to your question, Felicia, is yes, it could. But unless you’ll soon be in the hunt for a mortgage or other loan, it may not matter all that much.
Let’s take a look at the logic behind that answer. It has to do with your “credit utilization ratio.”
Higher credit utilization ratio = lower credit score
“Credit utilization ratio” is a $2 term for a 50 cent concept. It’s simply the amount of credit you’re using compared to how much you have available. For example, if you’ve got a credit card with a $10,000 limit, and your balance is currently $3,000, you’re using 30% of your available credit. So, your credit utilization ratio is 30%.
The most widely used credit score, the FICO score, penalizes those using too much of their available credit. This makes sense: Nobody wants to lend money to someone up to their eyeballs in debt. So, keeping your credit utilization ratio low by not using all your available credit is a good idea.
Most experts suggest keeping your credit utilization ratio under 30%.
So, now that we know that, it’s time to ask Felicia a question: Are you going to continue using your credit card? If so, will you be charging more than $600 on it? That’s 30% of your $2,000 credit limit. If you’re going to carry a balance of more than $600, your credit utilization ratio will be more than 30%, and that could ding your credit score.
Keep in mind that it may not matter if you pay your card off at the end of the month. Since your credit score could be pulled randomly at any time, merely having a balance bigger than $600 could theoretically hurt your score.
How much damage would it do? Utilization ratios, along with the total amount you owe, make up about 30% of your credit score. So, that’s a pretty big deal. Other things included in your score are the length of your credit history, your credit mix and, of course, your payment history.
But now I need to ask Felicia another question: Felicia, why did you lower your credit limit? If the answer is, “No reason, really,” then I’d probably suggest she move it back up to $10,000 and keep her utilization ratio as low as possible.
But what if Felicia said, “The reason I lowered it is because that high limit got me into a bunch of debt trouble. I don’t ever want that to happen to me again.”
If that’s the case, I’d say to keep your limit where it is and simply try not to use your card. Why? Because being in too much debt sucks. And if you find you can’t handle the temptation of a $10,000 credit line, fine. Screw all this nonsense. Do what you need to do to protect yourself.
Hope that answers your question, Felicia. Now, what about you? Got a question of your own to ask? Then do what Felicia did: Simply hit “reply” to any Money Talks email newsletters and fire away. I can’t answer every question, but I do my best.
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I’m Stacy Johnson. See you here next time!
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The questions I’m likeliest to answer are those that come from our members. You can learn how to become one here. Also, questions should be of interest to other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.
I founded Money Talks News in 1991. I’m a CPA, and I’ve also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate.
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