Banks Lowering Consumers' Credit-Card Limits

Updated on November 14, 2008. 

It’s not just your portfolio that may be shrinking during these turbulent times. The spending limit on your credit card may be heading south as well.

Credit-card issuers, including American Express (AXP), have been decreasing credit limits in the wake of the subprime meltdown. The banks’ concern is that consumers have access to credit limits that they can no longer repay, says Scott Bilker, founder of DebtSmart.com.

Folks with good credit scores and solid credit histories are now getting caught in the fray. "Most banks are cutting their credit limits," says Carol Kaplan, spokeswoman for the American Bankers Association. "People with credit scores of at least 720…are not immune. They're doing it to everyone."

According to a Federal Reserve survey, about 65% of domestic banks in July -- up from around 30% in April -- tightened their lending standard on credit-cards loans. Poor market performance and headlines questioning the viability of large financial institutions have contributed to a sense of fear among credit-card issuers, says Bilker.

Earlier this year, American Express adjusted the credit lines of 20% of its credit-card holders. (This does not include holders of its green, gold and platinum charge cards.) This is something that the company does on an ongoing basis – but what’s unusual this year is that 50% of those customers saw their credit lines reduced, says American Express spokeswoman Kim Forde. Prior to the subprime meltdown (which started last summer), only 20% of customers typically experienced cuts during these periodic reviews.

Smaller credit lines spell trouble for consumers on several fronts. Lower credit limits shrink consumers' abilities to spend. And should an emergency arise, like a medical issue or temporary unemployment, consumers will have less credit to cover those costs. Consumers could also trigger penalties for going over a credit limit that’s lower than they thought.

Those who carry credit-card balances will also see their credit score drop, says Daniel Ray, editor-in-chief of CreditCards.com. Roughly one-third of your FICO credit score is influenced by how close you are to your credit card's limit, says Gerri Detweiler, credit advisor for Credit.com. Someone with a $5,000 balance on a card with a $15,000 limit is using 33% of their credit line. But if that limit drops to $7,500, they're now using 66% of their available credit. Higher utilization rates (the amount of a credit line that you use) result in lower credit scores, which makes qualifying for a car loan, mortgage or home equity line of credit more difficult, says Ray. (For more, click here.)

Here's how to protect yourself:

Carrying credit-card debt is never a good thing, but it’s really not a good idea these days. Bigger balances make consumers prime targets for credit-card companies looking to reduce credit lines, since the banks worry that you may not be able to pay your tab.

To kiss that debt goodbye, allocate a percentage of your monthly income to tackling debt and look for 0% balance transfer offers. If your budget is already stretched thin, consider a part-time job, says Sheryl Garrett, fee-only certified financial planner. Our worksheet can help you figure out how long it will take to be debt-free.

When credit-card issuers lower credit limits, they must notify you. Typically, that will be done by mail (unless you’ve agreed to online-only notification). So pay attention to what’s sent to you. You should also review your monthly statement for changes, including a lower credit limit, interest rate spikes and new penalties.

Credit-card issuers review consumers' credit reports for red flags, like late payments to other credit cards, a sudden build-up of debt or high credit utilization rates, says Kaplan.

Check your credit report for free at annualcreditreport.com, and if it includes any errors, report them to the three major credit bureaus, Equifax, Experian and TransUnion.

Ask your credit-card issuer if they offer online alerts that notify cardholders when they're nearing their credit limit. This will prevent over-the-limit fees.

If your credit limit gets slashed, don't cancel your credit card. That will decrease your credit score. Instead, shop around for more attractive credit card offers, says Ray. Web sites like CreditCards.com and LowerMyBills.com help consumers compare offers.