Credit-Line Decreases Catch Consumers Unaware

That was just the beginning of their worries. A quick call to American Express revealed that Sak's nine accounts with the company — he has three personal and six business credit cards for his two businesses — had been singled out for financial review. All accounts were temporarily frozen and AmEx requested documentation proving his income: pay stubs, bank statements or a completed IRS form 4056-T, which authorizes the company to receive a transcript of his tax returns.

Worst of all, his credit limits were severely reduced. His AmEx Blue Cash card, for example, went from a $21,000 credit line to a mere $500. Since his balance at the time was $600, the cut pushed Sak over his limit. (AmEx later waived the $35 over-limit fee because of his good payment history.) Overall, Sak's credit limits went down from an average $15,000 to less than $5,000 per card, bringing his total debt utilization ratio — his balances compared with his credit lines — to a precariously high 99%.

Any credit-savvy consumer would guess what happened next: Sak's credit score plunged 40 points, to 640. AmEx told Sak they would consider reinstating his limits after evaluating his credit report for the following month. But Sak figures chances are slim with that credit score drop. Furthermore, all this will likely cause his other creditors to hike their interest rates — or even follow suit and cut his credit lines, as well.

Credit-card companies aren't exactly famous for reducing their cardholders' available credit. "Normally, they jack up your credit limit to encourage you to buy more and spend more," says attorney Howard Strong, author of "What Every Credit Card User Needs to Know."

But lately, it seems more consumers than ever are complaining of credit limit cuts that come out of the blue — a move that can snowball into debt disaster if not properly addressed. Curtis Arnold, founder of the consumer credit-card web site Cardratings.com, which features an active community forum on credit-related topics, has noticed dozens of recent posts complaining about credit-limit cuts.

What's going on? It can only be speculated. An American Express spokeswoman said the company reviews card member accounts "on a regular basis, based on a number of factors including payment history, out-of-pattern spending and changes in credit reports." Beyond that, she was short on specifics about which factors actually lead to the decision to decrease a customer's credit line. She did, however, deny that having too many credit lines or available credit are among those factors.

If past is prologue, credit-limit decreases — and American Express is not the only credit-card company doing this — is a reaction to what creditors perceive as increased risk of defaults. Hurricane Katrina, for example, left thousands of people relying on credit cards for food and necessities and at a greatly increased risk of filing for bankruptcy. One of the most common stories John Ulzheimer, president of Credit.com Educational Services, heard during his visits to the area was that of credit-limit decreases. It appears that certain creditors were engaging in a practice called "chasing the balance." Creditors not only lowered a person's credit limit to match their current balance, but every time the consumer made a payment on the account, they lowered the limit yet again, thus leaving consumers at 100% utilization month after month.

"They were doing it to prevent people from spending on their cards," says Ulzheimer. "There are two ways to mitigate risk with a credit card: Shut down the limit or increase the interest rate."

To be sure, in lieu of a skyrocketing interest rate, a credit-limit decrease appears to be a better option for credit-laden consumers. "Raising your interest rate is overkill, it makes the problem worse," says Ed Mierzwinski, consumer program director at U.S. Public Interest Research Group, a consumer-advocacy group. "The consumer ends up owing over a longer time, whereas decreasing a credit limit can be more reasonable."

Problem is, when that decrease is unexpected, it can be just as damaging to one's financial situation. "You've got to think of the collateral damage," Ulzheimer says. "You could affect the consumer's score in a way that leads other issuers to increase their rate. And then it can snowball because payments will increase."

Not to mention the potential damage of exceeding your limit if you're not aware it has been reduced. Charlotte White, a 54-year-old teacher in Memphis, Tenn., had her Juniper card for more than a year when last month she logged into her account to find her limit had shrunk from $5,500 to $2,600. Her balance, previously less than 50% of her credit line, was now more than 90%. "I could have been very embarrassed if I'd tried to charge a $300 ticket," says White, who asked us to change her last name for privacy concerns. "It wouldn't have gone through and I wouldn't have known why!"

That's assuming, of course, that Barclays, which recently acquired Juniper, would block the charge for lack of available credit. The much more common scenario would be to let the charge go through and slap on an over-limit fee, Mierzwinski says, which is no less annoying and will cost you at least $35. By press time, Barclays had not returned our calls seeking comment.

Decreasing a customer's credit limit may be a way for credit-card companies to control risk, but it can easily backfire. Take 35-year-old LaRonda Jones, a government agency program specialist who lives in Walkersville, Md.: She took her AmEx credit limit decrease from $3,600 to $2,900 in stride earlier this year, immediately paying off her balance. But at the beginning of this month, she applied for and received a Discover card with a $5,000 limit. Just weeks later, she noticed that her credit line was cut to $2,400 — she had had enough. The company told her it was reducing her credit line because she had too many open credit accounts, but those were there when her card was initially approved, she explains. She plans to close the account without ever using it. "I'm not giving them any money in interest, forget them," she says. Discover did not return our calls by press time.

Here's what you can do to prepare yourself for a credit-limit decrease.

1. Monitor your account
Credit-card companies are required to notify you by mail if they change your credit-card terms — including reducing your credit limit — but receiving that letter could take days, if not weeks, says Gerri Detweiler, author of "The Ultimate Credit Handbook." By frequently checking your account activity online, you will notice a limit decrease much sooner.

2. Make credit available elsewhere
Keep one or more credit cards with $0 or low balances handy, Detweiler recommends. Ideally, they will have credit lines large enough to allow you a balance transfer from the credit card that cuts your credit line. This way, you'll avoid high debt utilization ratios that hurt your credit score.

3. Be a good customer
Creditors are more likely to reduce your limit if they notice activities that imply you may be in debt trouble, Ulzheimer says. That could be anything from high credit utilization to late payments to applying for too much credit. Pretty much anything that could result in a credit-score decrease puts you at risk for facing a credit-limit decrease as well.