Today's guest post comes from Jim Wang, a personal finance blogger at Bargaineering.com.
It's not easy being a credit card company these days. Between the government tightening the rules on what credit cards can do and the economy pushing so many consumers into defaulting on their debts, credit card companies are scrambling to reduce their risk and make it to the other side of this recession. The easiest way for credit cards to reduce their risk is to lower credit limits as quickly as they can. Unfortunately, this has a negative effect on consumers like us and their latest tactic, balance chasing, is especially painful. So what is balance chasing? Balance chasing is when the credit card company cuts your credit limit down to a few hundred dollars over your balance. This usually happens when someone makes a large payment on their balance, which is akin to kicking you when you're down. What should've been a good thing has suddenly turned into a bad thing!
Normally, when you make a large payment on a credit card, your FICO credit score will likely improve. Your credit utilization, which is the amount of your total credit you are currently using, will go down because you just paid off a huge chunk of debt. When your utilization goes down, your score goes up because you're less risky.
When a credit card company drops your credit limit after a huge payment, you don't reap the benefits of a lower credit utilization. Imagine you had a $900 balance on a card with a $1000 limit (90 percent utilization). You get a bonus at work (awesome!) and pay off $500, lowering your balance to $400 (40 percent utilization). Under normal circumstances, that's good news for your credit score. Then the credit card companies sends you a letter telling you that your limit has been lowered to $450 due to an "increase in risk." Now your utilization jumps back to around 89 percent, meaning you don't get any credit score boost because the credit card company chased your balance.
What can you do to prevent this? The only thing you can do is not carry a balance! Besides that, some experts recommend that you don't make any large payments on your credit cards. Spread your payments out so that you don't show any abnormal activity.
One way you can help mitigate the damage is by requesting credit limit increases from other credit cards. Several companies offer automated credit line increase requests through their online account portals. For example, Citi will tell you instantly if they are willing to give you an increase without a credit check. If they want more information, it'll require a credit check. A credit check will hurt your credit score, so avoid those.
By increasing your limits on other cards, you help maintain that utilization figure and minimize the damage from a company that's balance chasing!