Lenders are reeling in the credit lines they were once so eager to bestow, and the results could be catastrophic for your credit scores.
Nearly half of banks have reduced customers' credit limits, a recent Federal Reserve report says, and lenders aren't done yet. Banking analyst Meredith Whitney predicts that credit card issuers will slash limits by more than half in the coming months, from about $5 trillion down to $2.3 trillion by the end of next year.
Lower limits are a potential disaster for consumers' credit scores because they change the all-important credit utilization ratio. Lenders like to see a wide gap between balances and credit limits; reduced limits narrow that gap, potentially damaging your scores.
You're vulnerable even if you pay your balances in full every month, as I explain in my book "Your Credit Score: Your Money & What's at Stake," which was recently published in a third edition.
That's because the balance used in credit-scoring calculations is typically the one from your last statement, before you sent in your payment. A suddenly lower credit limit can make it look like you're maxing out your card, even when you're being responsible by paying in full.
Here's what you need to know to protect yourself:
1. Diversify your creditYou may think all credit card issuers are alike, but they're not. Their policies and business models differ, which is why some are slashing credit lines much faster and more broadly than others. Having all your credit cards with a single issuer has always made you vulnerable to that lender's whims, but these days, such loyalty could be devastating to your credit if all your accounts were reduced or frozen at once.
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It's become clear: We need to diversify our credit accounts just as much as our investments. In addition to cards from two or three major issuers, consider a card from your local credit union, which is member-owned and not as exposed to the credit crunch as major banks.
Don't apply for this credit all at once, however, because that can hurt your scores, too. Spread your applications over several months, and don't apply for new credit at all if you're in the market for a major loan such as a mortgage or car loan.
2. Spread out your debtIdeally, you'd pay your credit card in full every month. If you're carrying a balance, however, consider spreading it over several cards.
Carrying smaller balances on several cards is better for your scores than having a big balance on a single card. If the limits are lowered on any of your cards, you can shift part of that balance to another account to lower your credit utilization.
3. Push back -- if you have good creditThe better your scores, the more leverage you have with lenders, who are still eager to attract and retain low-risk customers. (See "Protecting your credit scores.") Anyone with scores of 700 and above on the 300-to-850 FICO scale is generally considered to have good credit; scores of 750 or above mean you have excellent credit and can easily move your business elsewhere. Point that out to the card issuer that's trying to lower your limits. If it won't budge, follow through on your threat.
Sites including CardRatings.com, CreditCards.com and LowCards.com can help you track down competing offers. For more details, read "Thaw out your frozen credit." (Don't know your FICOs? You can buy one credit score from myFICO.com for $16 or get a free estimate of your scores by taking MSN Money's 10-question quiz.)