They Reduced My Credit Card Limit - Does it Hurt My Credit Score?

"My bank recently reduce the limit on my credit card, and I have no idea why. Why would they do this if I've never missed any payments before, and how does it affect my credit score?"

This is one of the most common questions we've been getting from readers lately, and there are two reasons for it. Recent statistics have shown that roughly 1/4 of all credit card holders have had their credit limits reduced within the last six months. The recession has a lot to do with this. In particular, the mortgage and housing crisis that fueled our recession has caused a lot of lenders to minimize their risks.

Credit cards are a classic form of risk for banks, because they are not secured by any form of collateral (with the obvious exception of a secured credit card). So many banks have reduced credit limits for thousands of the customers, as a way of minimizing this risk.

That's one reason they are reducing limits on cards. But there's another reason as well. Starting in July of 2010, some new laws will go into effect to regulate what credit card companies can and cannot do. A lot of the things they have done to make money in the past will no longer be permitted. Some of their favorite tricks and tools for making money will be outlawed. Because of this, many banks are less willing to take risks. The money they have made in the past over penalty fees and other charges has offset their financial risks. But if they can no longer use these tools to make so much money, then they must scale back on the amount of risk they're willing to accept.

In most cases, the people who are finding their credit limits reduced fall into a certain "profile." The banks use various formulas and criteria to determine which customers are most likely to miss payments on their cards, and then they reduce the credit limits for these people.

This is usually why it happens, but not always. I have received quite a few emails from people who had their credit card limits reduced recently, even though they never missed a single payment in the past. Sometimes the banks apply these rules across the board, and other times they use certain formulas to identify high-risk customers. It just depends on the company.

Does a Reduced Credit Limit Hurt Your Score?

The usual follow-up question we receive on this subject has to do with credit scores. What happens to your score when the bank reduces your limit on a card? The answer is that it depends. Your score may go up, it may go down, or it may remain unchanged. It depends on what else happens in conjunction with the limit reduction that has been imposed.

Generally speaking, a reduced credit limit would lower your score, because it makes it seem like you are using a higher percentage of your available limit. For example, if you are using 15% of your available credit card limit, and then the bank lowers the limit by a significant amount, your utilization ratio will increase. In other words, the percentage of your available credit that you are using will go up. This happens even if your balance stays the same, because it's not a measure of how much you owe -- it's a measure of what you owe compared to what's available. In other words, it's a comparison between your current credit card balance and the limit you have available on your credit line. So a reduced limit will actually increase your utilization ratio, and that can affect your credit score in the long run.

The best thing you can do if your bank reduces your limit is to pay down your balance. By doing this, you will minimize the changes to your utilization ratio, and therefore minimize the impact on your score.

Keep in mind also that there are several factors that influence your credit score. See the scoring chart below for an illustrated example of this.



The amount you owe on your cards compared to your credit limit (i.e., utilization ratio) is only one of five key factors. Your payment history is another major factor, and it influences your score more than a credit limit reduction. So if you continue to make all of your payments on time, and if you can pay down your credit card balance to compensate for the reduced limit, you could prevent any damage to your score.

Fixing Your Credit Score in 2010 - You Should Start ASAP

If you are planning to buy a home next year, in 2010, should review your credit score right now. If your score is high, you're in a good position to apply for a mortgage loan. But if it's low, you need to work on fixing your credit score before you start applying for loans. Here's why.

Mortgage underwriting guidelines will be stricter in 2010 than they were in the past. Lenders are simply unwilling to make risky loans these days, following the wake of the subprime crisis that devastated our economy. So you will need to have your financial ducks in a row if you want to be approved for a loan. Among other things, this means fixing a bad credit score (if you happen to have one). Here are some tips to help you do that.

Start by Getting Your Credit Score

The first thing you need to do -- obviously -- is obtain your FICO credit scores from all three of the reporting companies (TransUnion, Equifax and Experian). The FICO score is the one most lenders will look at when considering you for a loan, so it's the only one you should care about right now. To learn how to purchase your scores the right way, check out this important lesson.

Note: As of February 2009, Experian (one of the three credit-reporting companies) stopped giving consumers access to FICO scores based on their Experian credit files. But you can still get your Experian PLUS score®. I know it's confusing, but that's how this industry works. Just know this. Your TransUnion and Equifax scores will based on the FICO scoring model, but your Experian score will be based on a different scoring model. Still, you'll get a good idea where you stand by looking at all three. If the score you get from Experian is wildly different than the other two (and the other two are close), then just forget about the Experian number and get on with life.

Do you need to work on fixing your credit score before applying for a mortgage loan? Well, in order to determine that, we need to talk about bad, good and excellent credit. Here's how to figure out where you stand.

What Score Do You Need?

What is considered a good credit score in the current economy? Here's my position on this. Good, bad, excellent, fair, poor, terrible ... just forget about these labels for now. They only confuse things. The only thing that matters is that you can (A) get approved for the loan and (B) secure a decent interest rate on the loan. In order to do that, you'll need to have a credit score above a certain number, based on the lender's underwriting guidelines.

You might get approved for a loan with a score of 660, for example, but you won't get the best rate with that number. In order to satisfy both of these goals (approval and good interest rate), you'll probably need a score of 760 or higher.

So, do you need to worry about fixing your credit score at this point? Well, if it's below the mid 600s, you definitely need to improve it. If it's in the low 700s, you'll probably get approved for a mortgage, but you won't get the best rates. If your score is in the mid 700s or above, you're in great shape. These numbers are not written in stone, mind you. But they do represent current trends and averages.

And remember, your credit score is not the only thing a lender will review. You'll also need a down payment of some kind, as well as sufficient income (relative to the amount you want to borrow). We will talk more about these "other" qualifying factors below. But for now, let's stay on the topic of fixing credit in order to buy a home.

Fixing Credit Takes Time - So Start Today

Here's an important point you should take away from this article. Fixing a credit score requires time, patience and persistence. It doesn't happen over night. Depending on the actions you take, it may take several months to improve your score significantly. It also depends a lot on your past credit history, so there's no way I can give you any estimates for reaching your goals. There are too many variables to put a time frame on it.

The point is this. If you plan to buy a home in 2010, and your credit score is lower than the ranges mentioned above, then you should start fixing it today. The sooner the better. The more you can boost that number between now and your first mortgage application, the better! This will help you get approved for the loan, and will also help you secure a good interest rate on the loan. This can save you thousands of dollars on your monthly mortgage payments.

Will you be fixing your score over the next few months? Need some guidance to get started? Here's an article + video that explains how you can raise your score quickly, in advance of buying a home. It's worth a look.

Other Tips for Buying a Home in 2010

So, what else can you do to increase your chances of getting a mortgage in 2010? We have talked plenty about your credit. But that's not the only piece of the puzzle. You also need to start saving money -- the more the better. You'll need some extra cash for your closing costs, moving expenses, and other "pop-up" expenses that are common during this process.

You should also continue your research, especially in the area of mortgage loans. This is where a lot of first-time buyers make big mistakes. So if you only read one more article before leaving this website, make it this article on mortgages. You'll be a wiser and better-prepared home buyer if you do.

I hope this lesson has helped you understand the dynamics of fixing a credit score, and I wish you all the best in your 2010 home buying process. Good luck!

Removing Negative Items from Your Credit Report

Reader Question: "I have heard people say it's possible to remove negative items from a credit report, but then I've seen other websites say that it's not possible. I'm confused, to say the least. Is it really possible to remove negative information from a credit report, and if so how do I get started?"

The reason you've seen so much conflicting information is because many people don't know what they are talking about. But this doesn't stop them from posting information online, or claiming to be an "expert" on the subject.

Once you know the facts about the reporting industry, it's really not confusing at all. It's mostly black and white, with very few gray area. Here is what you need to know about removing negative items from a credit report file:

Negative information can show up on your credit in several ways. It might be a history of late payments, a debt collection, a bankruptcy, etc. But all of these items can be classified in one of two ways -- they are either legitimate entries, or they are mistakes. This is an important distinction, because it determines whether or not you can remove a negative item from your credit report history. Let's talk about what you can (or cannot) do for each type of entry:

Negative information that is legitimate can remain on your credit report for up to seven years, or up to ten years for bankruptcy filings. Even if you pay off an old account that was reported as unpaid, it won't remove the initial posting from your report. It will change the account status to "paid," but that's it.

Negative information that is posted in error can be disputed. You can dispute such errors directly through the credit-reporting agency's website (Equifax.com, Experian.com or TransUnion.com). These companies are required by law* to investigate the disputed item. If they find that you are correct, or if they do not have enough evidence to support a finding, they must remove the negative item from your credit report file.

* Here is what the Fair Credit Reporting Act has to say about the dispute process. This is the federal law that regulates the reporting industry:

If the accuracy of any item of information contained in a consumer's file ... is disputed by the consumer, and the consumer notifies the agency directly ... the agency shall, free of charge, conduct a reasonable reinvestigation to determine whether the disputed information is inaccurate and record the current status of the disputed information, or delete the item from the file.

In other words, they must investigate the disputed item in a timely fashion, and if their findings support your claim the negative information will be removed from your report entirely. They must delete the erroneous item within 30 days from the time you first dispute it.

This quote comes from section 611 of the Fair Credit Reporting Act (FCRA). This section is entitled "Procedure in case of disputed accuracy." It goes into a lot more detail about the dispute process, how and when a negative item should be removed, etc. So if you want to learn more about this subject, I recommend reading this section. You can find the full text of the FCRA on the FTC's website.

When Do Lenders Check My Credit Score for a Mortgage?

Reader Question: "At what point during the home buying process does the mortgage lender check my credit score? Is there any way I can find out if my score is good enough, before I even apply for a loan?"

Different lenders have different application procedures, so it will vary slightly from one mortgage lender to the next. With that being said, most lenders will check your credit score as early on in the application process as possible. This benefits everyone, including you. They want to know if you're a good candidate for a loan early on, because it's a time saver. So they typically do this on the front end of the process.

In addition to your credit score, the lender will check your income level, the various debts you carry, and other qualifying factors.

Check Your Credit Score Early

You can check your own credit score, and I recommend doing this as soon as possible. By the nature of your question, I can safely assume you're planning to buy a home in the near future. If that's the case, you should know where you stand. You should know your current credit score, your debt-to-income ratio, and other qualifying factors.

It's important to do this early on in the home buying process, because if you find out your score is low, you will need time to improve it. With a bad credit score, you'll have a much harder time qualifying for a home loan. And even if you do qualify with bad credit, you certainly won't get the best interest rate.

That's why I always tell home buyers to check their scores early on, so they can make improvements if needed. This helps you get approved for a loan, and it also helps you qualify for a low interest rate.

How Lenders Check Your Credit

To put this into perspective for you, I'll outline the basic steps that take place when you apply for mortgage loan:

• You would submit an initial application through the lender's website or by visiting their office in person.
• The lender will review your income, your current level of debt, and a few other preliminary factors.
• Either at this stage, or shortly after it, the mortgage lender will also check your credit score to see how you have managed your finances in the past.
• If you measure up well in all of these areas, the lender will probably give you some form of pre-approval letter. Basically, they are telling you how much money they are willing to lend you based on your qualifications.
• If your credit score is too low, or you are carrying too much debt relative to your income, the lender might reject your application at this point. Likewise, they may turn you down if you're simply asking for too much money based on your income.

Like I said earlier, the process varies slightly from one lender to the next. It also varies based on whether you start the process online or in person. But this is generally how it works. They will check your credit score early on in the process, in order to save everyone time.

Don't Wait - Get Started Today

But you shouldn't wait until then -- you should check your score right now to see where you stand. That way, if you need to make improvements before applying for a loan, you'll have time to do so (it doesn't happen overnight).

Dealing With Debt Collectors - And a Sample Letter

Reader Question: "I have been receiving phone calls from debt collectors all throughout the day. They are rude and loud, and they call over and over about the same thing. I intend to pay what I owe as soon as I'm able, but in the meantime I want to be left alone. What do you recommend for dealing with debt collectors like this?"

The best thing you can do is pay off the debts that you owe, as soon as possible. Unpaid bills can stay on your credit report for up to seven years, during which they can lower your credit score. If it goes unpaid, it can be sold from one debt collector to another, which means it will be reported over and over again. So the best way of dealing with debt collectors is to pay what you owe -- as long as it's a legitimate debt.

I know you're aware of this, but I had to include it for other readers. So let's move on to the question you asked. What can you do in the meantime, while you are trying to pay off the debt? How do you deal with rude and annoying debt collectors who call you all the time? Fortunately, there's an easy solution to this. You can send them a written notice to stop contacting you. They are required by law to honor that request.

If you are being hounded by debt collectors, you are not powerless. You can simply ask them to stop contacting you (in writing), and they must honor that request. If they ignore the request, then they are violating the Fair Debt Collection Practices Act (FDCPA).

Here's a sample letter you can use to get debt collectors to leave you alone:

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Sample Letter for Collection Agencies

Your Name
Your Address

Date

Name of Collection Agency
C.A. Address
Subject: Debt Collection Against [Your Name]
Creditor Name: [Creditor]
Account No. [Number]


To Whom it May Concern,

In accordance with the Fair Debt Collection Practices Act, I am sending this written request that you stop contacting me about my account (see creditor and account number above).

[If you intend to repay the debt at some point, like when you find a job, you could include a brief message to that effect. But I wouldn't offer too many details. Keep it simple.]

Sincerely,

[Your Name]

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Pretty simple, right? This is the best way of dealing with debt collectors who call you over and over, or harass you in some other way. Don't call them names. Don't use profanity. Be professional and get straight to the point. The law is on your side when it comes to dealing with these folks, so you don't need to resort to a shouting match. Just send the letter and keep track of any communications after that (in case they ignore the letter in violation of the FDCPA).

If they violate this law, and you can prove it in a court of law, you could win a judgment against the collection agency. If you win such a case, you could recover any damages you've incurred plus your legal fees. In most states, your first line of defense is the state attorney general's office. You can also report the debt collectors to the FTC, which is the federal agency that enforces these laws.

Dealing With Collectors Does Not Erase the Debt

It's important to point out that this does not make your debts go away. It's simply a way of dealing with debt collectors who call you constantly. They must stop calling if you send a letter like this, but you will still owe whatever you owe. In fact, you could still be sued for a legitimate debt, even after sending a letter like this. It's stops their communication, but it does not take away their legal right to file suit.

I've said it before, but I'll say it again. The best way to permanently solve the problem is by paying what you owe. This will help you restore your credit, and it will eliminate the emotional strain of having unpaid debts. This kind of situation can wear on you over time. It can take an emotional and physical toll. So do whatever you can to resolve it once and for all, even if that means getting help from a non-profit debt counselor.

Disclaimer: This article is a general guide to dealing with collection agencies. It should not be taken as legal advice. If you feel you are being harassed by a debt collector, you should contact your state attorney general's office for help. You should also familiarize yourself with the Fair Debt Collection Practices Act, which is linked to above. Remember, the law is on your side when dealing with these people, so you must first understand the law and the rights you have.