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Experts Warn Consumers about Adverse Impacts of Credit Card Cuts on Scores

By Sally Maison
Published: Tuesday, October 27th, 2009

As 2009 enters its last quarter, struggling banks were beginning to close card accounts with barely any warning. Among those banks is lending giant Citi, which started closing reward cards for select clients this week. While some consumed this positively because it frees them of some payment obligations, finance experts say this also takes away a significant credit line for consumers, which adversely impacts their rating. Experts add that such changes have neutral effects on consumers with good credit scores, but it means a lot to those who are struggling to keep their rating.

Just this August, many banks trimmed down debt limits for their clients in order to keep them accumulating huge debts. Card delinquency has become a major issue for banks which caused them to lose billions of dollars. This month, banks did not only cut limits but closed consumer accounts as well.

Experts say that closed credit card accounts either neutral or negative effects on consumers. According to Fair Isaac Company (FICO) which designed the most widely used consumer scoring method, having a cut on the credit card limit is worse than getting one’s home equity downsized. FICO says the proportion of combined balances with combined debt limits is an extremely important factor in consumer scoring. The company explains having a low debt-to-credit ratio is very significant in getting high ratings.

As illustrated by specialists, a consumer who has a $1,500 balance on one card will have a debt-to-credit ratio of 15 percent if the combined limit of all his cards is worth $10,000. If one of those cards with a credit limit of $2,500 gets cut off, his debt-to-credit ratio will climb up to 20 percent, which is not a significant factor for those who have managed their debts prudently. However, consumers whose debt-to-credit ratio is already beyond 50 percent at the time of the cutoff will suffer greatly. Experts say consumers who utilize less than 20 percent of their credit line are more likely to get approval from lenders. More importantly, they save more money than those with low credit scores, since they are charged with lower interest rates.

Specialists warn consumers that card accounts can be closed without warning since no law, not even the recently signed CARD Act, mandates bank to issue notifications before cutting clients off. For this reason, they advise consumers to avoid utilizing much of their debt limits.

In August, only 9 million out of 33 million Americans whose cards were closed saw their credit score drop. Specialists advise consumers to pay balances on time so they can have cushioned against sudden account closures.

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