Many cardholders saw issuers lowering their credit limits in April and May, as companies started evaluating the creditworthiness of customers, whose cash flows got impacted due to the covid-19 lockdown. Many cardholders didn’t realize that lowering the credit limit could impact their credit score if they have an outstanding balance on the cards.
When calculating credit scores, credit bureaus look at several parameters. One of the key parameters is the usage of cards compared with the credit limit. This is called credit utilization. “Credit utilization is the ratio of credit card outstanding to the credit limit and it can impact 20-30% of a credit score," said Wilfred Sigler, director, sales and marketing, CRIF India, a credit bureau.
The credit bureaus give a high weightage—up to 30%—to credit utilization when calculating the credit score.
Depending on how high the ratio is, your credit score can take a hit. If an individual has never used a card, the credit utilization would be zero. Similarly, for someone who had ₹4 lakh credit limit and an outstanding balance of ₹50,000, the credit utilization ratio would be 12.5%. But if the issuer reduces the credit limit to ₹75,000 and the outstanding remains the same ( ₹50,000), the credit utilization ratio will be 66.67%.
If your credit limit was cut recently and you have an outstanding balance, your credit utilization will shoot up, which will affect your credit score.
What you should do
If your card limit has been lowered and there’s an outstanding balance, you must repay the dues to lower the credit utilization. As you bring down the outstanding balance, your score would improve.
According to the credit bureaus, individuals should keep credit utilization of 30% or below.
The preferred credit score varies from lender to lender. Public banks can offer loans with a credit score of 700 or more. Private banks have a higher score requirement. Non-banking financial companies give loans with a score of even lower than 700.
If you are planning to take a loan, a lender would also look at other parameters to evaluate your application. “One-off high credit utilization will not impact borrowers seeking a loan. Only if the credit utilization ratio is high month after month, a lender may look at it negatively," said Ashish Singhal, managing director, Experian Credit Information, a credit bureau.
If your credit limit has been lowered recently, make sure that you clear the dues over the next few billing cycles so that your credit score is not impacted.