The following is a contribution from Jerry over at Repaid.Org. If you’d like to contribute to Wise Dollar, please contact us.
From time to time I come across a question that needs to be answered. Recently, this question was posed over at my home blog, Repaid.org:
Should I have my credit card limits lowered so I can avoid having high debt?
The person asking the question has a history of carrying a high credit card balance, but has recently paid down a considerable amount of that debt. Despite making inroads on their credit card balances, they are worried about backpedaling. It is great that they have recognized their struggles with credit card debt and paid a chunk of that debt off, but reducing limits may not be such a good idea.
The Basics of Credit Utilization
FICO builds thirty percent of your credit score based on the amounts that you owe on current credit accounts. That calculation takes into account your credit utilization ratio. Your credit score gets a boost if the balance on revolving credit accounts (credit cards) is under 30 percent of the available limit. On the other hand, your score suffers if the ratio is greater than thirty percent.
If you have a credit limit of $10,000 and a balance of $2,000, you are sitting pretty at twenty percent. Lower your credit limit to $5,000 as a way to prevent yourself from overspending and your ratio jumps to forty percent. That jump in your credit utilization ratio could drop your credit score a fast fifty points. It could take several months for you to pay the $500 plus interest necessary to get your ratio back down to a desirable level.
Don’t Close Those Credit Card Accounts Either!
Another option often considered when people want to keep their debt down is to close credit card accounts. That can be more damaging to your credit score than lowering your credit limits. While the length of your credit history only accounts for fifteen percent of your FICO score, it is the hardest to recoup. You can pay down a high utilization ratio, pay off old debts, etc, but the only way to boost the length of your credit history is to wait for years to pass.
From personal experience, I have found that a great way to keep your spending down is to force yourself to reconsider credit card use each time you feel like reaching for one–a common habit of the debt-free. I did that by putting my credit cards in a locked toolbox that is in the shed at the rear of my property.
In the beginning, I started out to the shed to get one of them on a regular basis. The time it takes to walk out there was spent rethinking the need and wisdom of using a credit card. Quite often, I talked myself out of buying whatever I had on my mind with a card and saving for it instead. Which leads me to the second option.
The second option is to tweak your budget so that you can save for items that you are tempted to purchase with a credit card. While you are saving for something, you may find that what thought was a need is only a want and reconsider the purchase altogether.
Check Your Card Issuer’s Terms
After you find the right place to hide your cards from yourself, you may want to look through the terms for each credit card. Some card issuers will automatically close an account if these is no activity on it for a certain period of time. If that is the case, simply charge something small. Something that you can pay for the same month that you charge it.
Hiding my credit cards from myself helped me to repay a large credit card debt and learn a new way to use those cards. Hopefully, you will be able to do the same or find another way to control your spending without damaging your credit score as mentioned above.
What are some ways you’ve been able to control your credit card spending in the past? Did you ever do anything like freeze or lock up your credit cards? How soon after paying off debt did you get a new card?
Jerry Coffey is a self-described recovering “debtaholic” who went deep into a spiral of spending, debt, bankruptcy, and assorted money woes before breaking the cycle with a frugal lifestyle. Now he shares his experiences and advice over at Repaid.org.
Photo courtesy of: David Huang
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