| June 26, 2015

Research of the Week: Credit Limit Catch 22

Limits down 11% from last year. Is it good or bad for your bottom line?

Each week, Consolidated Credit searches for financial research that can help you deal with your debt and budget. This week…

The interesting study

Burdened by high credit card limits

Credit.com recently published a data study from Experian  that shows what’s happened to consumer credit limits over the past year.

A “credit limit” is the amount of available to borrow against on a credit card, and it’s typically at least partially determined by a consumer’s credit score – a higher score means creditors are more willing to extend bigger credit lines. On the flip side, credit limits also play a role in your credit score calculation, as well as your ability to manage debt effectively.

The big result

Nationwide, credit limits dropped an average of 11% in 2015 from the same time last year. This doesn’t mean creditors are decreasing existing customers’ credit lines. It means new accounts being opened have lower limits starting out.

The fascinating details

According to Experian, $77 billion in new credit card accounts were opened in the first quarter of this year – that’s $6 billion less than the $71 billion opened last year in the same time span.

Here’s what average credit limits on new accounts look like across the various credit scores you can have:*

  • For “super prime” consumers with a 781-850 credit score
    • Average limit this year = $9,543
    • That’s smallest decrease from last year of an group at 0.6%
  • For “prime” credit scores (661-780)
    • Average limit in 2015 = $5,209
    • That’s down 3.2% from last year
  • For “near prime” consumers with a 601-660
    • Average 2015 credit limit = $2,277
    • Limits are down 8.8% from last year
  • “Subprime” consumers with a 500-600
    • Have an average new credit limit of $966
    • … Which is down 17.5% from last year
  • Finally, for “deep subprime” with scores of 300-499
    • The average limit = $509
    • It’s down a whopping 25.9%

*The credit scores used in this study were VantageScore 3.0 from Experian. Notes that other credit scores, including FICO will have different ranges from what’s shown above.

What you can do

So overall, credit limits have decreased from this year to the last and there’s not much you can do about that. As you can see, even if you have excellent credit, the limit you’d get on a new account this year may be less than what you’d get approved for last year and it has nothing to do with your personal financial outlook or credit score – it’s just an effect of current market conditions. In other words, creditors are tightening their purse strings overall.

Still, as you can see from the data, they’re tightening a lot more at the bottom of the credit score barrel than they are for those with the highest scores. So the higher your credit score, the less likely your credit limits are to fluctuate as dramatically as what you see at the “deep subprime” level.

Now here’s where things get interesting – your credit limits have at least some correlation your ability to maintain a high credit score.

Here’s why:

  1. “Credit utilization” is the second most important factor in your credit score.
  2. It’s calculated by dividing your total accounts balances by your total available credit limit
    Total balances on all your credit cards / sum of all credit limits x 100 = Utilization ratio
  3. The lower your credit utilization ratio, the higher your credit score

As the Credit.com article states, “Many experts recommend keeping your credit card balances at less than 30% over your overall available credit, though those with the best credit scores keep their utilization to less than 10%.”

This is where the Catch 22 comes in – higher credit limits may mean it’s easier to maintain a low credit utilization ratio because you have so much credit available. However, high-limit credit cards also make it more tempting to overspend because you have all of that available credit to use. It’s really easy to just let your balances run up to buy what you want, when you want it.

“When it comes to high-limit credit cards, it’s about having the self-restraint to avoid running up your balances and letting the debt get out of control,” says Gary Herman of Consolidated Credit. “It’s up to you to manage the debt effectively and be strategic about paying it off – for instance, eliminating balances in-full every month on daily purchases you make to earn rewards, while putting larger purchases on low-interest cards so you can pay it off strategically over time.

“But you never want to allow your balances to run up,” he continues, “especially with these high-limit cards that can be difficult to pay off quickly if you’ve overcharged all the way up to your credit limit.”

No matter what your credit limits are, the one thing that you have control of in this circumstance is your total credit card balance. Whether you have high or low limits, you should never be using more than 1/3 of your total available credit at any given time – and in actuality, each credit card must be maintained at 30% of the available credit limit or less in order to maximize your credit score. However, more than that this balance of 30% helps ensure you can retain control over your debt instead of allowing it to take control of your budget.

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