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Steve Bucci has been helping people decode and master personal finance issues for more than 20 years. He is the author of “Credit Management Kit For Dummies,” “Credit Repair Kit For Dummies,” “Barnes and Noble Debt Management,” co-author of “Managing Your Money All-In-One For Dummies” and “Debt Repair Kit For Dummies” (Australia). Steve is an experienced expert witness in identity theft, credit scoring and debt related cases. He has been a presenter at the FICO InterACT Global Conference, the Federal Reserve and the International Credit Symposium at Cambridge University in the UK.
Ask Steve a question, or see if your question has already been answered in the Keeping Score answer archive.
Should I ask my issuer to reduce my credit limits after my debt is paid off?
Lower credit limits can hurt your credit score if you continue to carry balances on your cards after paying off your current debts. If you have less available credit, your credit utilization ratio will increase more quickly as you use your cards.
Check out all the answers from our credit card experts.
Dear Keeping Score,
I am about to pay off all my credit card balances using funds from a retirement account loan. I am thinking of asking the credit card companies to lower my credit limit, keeping the cards open, after I pay off. Would this decrease my credit score? Would it matter if I wait a month or two after paying off, before asking for a reduction in my credit limits (thinking of 1/2 credit limit)? My credit score currently is 785, and lowest credit limit is $5,500 and the highest $18,800. -Jen
Unless you are over 59 and a half years old, this is a “very bad” idea. If you are over 59 and a half then this may only be a “bad” idea.
Either way, I want you to look long and hard before you spend retirement dollars on credit card debt. I would much rather see you suspend new deposits to your retirement account and use that money to systematically pay off your credit cards. Yes, this probably will take longer, but it is so much safer.
Safer how? Did you know that if you leave your job to take another opportunity, the loan could become due? It may also become due if you are laid off or terminated. This is usually the worst time to have an unexpected loan fall on your shoulders. Any loan will have to be repaid in full by the next date your taxes are due or you will be taxed on the loan. If you’re under 59 and a half, you’ll be hit with a 10 percent penalty as well.
For example, if you are a 50-year-old employee and you are in the 24 percent tax bracket with a $5,000 loan and change employers, you have to pay the loan back by your next tax time. If you don’t pay it back by then, you will owe $1,200 in income tax on the distribution plus a $500 early withdrawal penalty. And this is in addition to any fees your plan may charge for the loan and the loss of any investment gains that you miss out on. My suggestion is that you shop around for a less risky type of loan.
I would also suggest that you suspend contributions to your retirement account and use that freed up cash to pay down your credit cards. If you’re really serious about dumping your debt, also allocate half of any future raises and bonuses to the payoff. This will speed matters up significantly. While you may pay more in interest initially, you may be better off in the long run.
Tip: Paying off multiple credit balances can backfire, especially if it prompts an account review by your card company. You could get higher credit limits or 0-percent promotional offers, but you may also end up with lower credit limits or the cancellation of accounts.
Reducing your available credit can hurt your score
Now, let’s address your question about credit limits! The short answer is reducing your credit limits before you pay off your cards will reduce your score. If you wait until the cards are paid down to zero, it will depend on how much you charge each month and if you think you may carry a balance at some time in the future.
This is because you will effectively change your credit utilization rate, which is tied to your available credit and makes up 30 percent of your score. This piece of the credit scoring pie is second only to payment history in importance to your credit score. In a nutshell, if you have a card with a $10,000 limit and charge or carry a balance of $1,000 your utilization rate would be 10 percent. Lower the limit to $5,000 and the same balance yields a 20 percent utilization rate. Higher utilization rates lower your score.
You have an excellent score and I am curious why you want to do this. While I would never advocate using all of an $18,800 limit on a credit card (or even $5,550 for that matter), having those large limits has helped afford you the score you own today. I am happy to see, though, that you know you need to keep these accounts open. Your credit history, while not as important as payments and utilization, is important to your score, too.
Now let’s talk about what it will mean if you go ahead and ask for a credit reduction on your cards. First of all, waiting a month or two will likely not make a whole lot of difference. But I am limited in what I know about your accounts.
See related: Credit card limit decreased? Why it happens and what to do about it
Your current score tells me you must not be close to maxing out your cards even though you are likely at a higher utilization than I generally recommend, which is only five to 25 percent. If I were to guess, I would say you are somewhere in the 35 to 50 percent range. Once the cards are all paid off it is likely your score will rise somewhat, because you will have reduced your utilization. Zero is a great number here.
Lenders want to see that consumers can be responsible with the credit they are given. Whatever you decide – a credit reduction or not – you will want to use your cards in a way that will benefit you the most. This means not charging more than you can comfortably pay off within 30 days.
Over the years I have learned it is nearly impossible to get debt under control unless you stop adding to it, so be sure not to make any charges that you can’t pay off each month. And, of course, be sure you pay your bills on time, each and every month.
Remember to keep track of your score!