Myth No. 2:
High credit limits or large amounts of unused credit will lower your score
As long as you don’t use that credit and add to your debt, having high credit limits on your cards is actually a good thing. Your debt-to-credit ratio, which makes up 30 percent of your FICO score, is the amount of revolving debt (i.e. the credit card balances) in relation to the amount of available credit (i.e. the credit limits). This calculation is used by Credit Bureaus to determine your ability to manage the credit you have. Ideally, you’d want this ratio to be under 30 percent.
For example, let’s assume that you have 3 open credit cards with limits of $5000, $7000 and $6000, equaling a total credit limit of $18000. Your balance on one card is $1700, on the second card it’s $1200, and on the third it is $2100; equaling a total balance of $5000. So basically you have used $5000 out of the $18000 available to you, resulting in a debt-to-credit ratio of 28 percent. This is to say, that only 28 percent of your available credit is being utilized at this time. The higher the percentage, the more likely you could be considered overextended which hurts your score.
How it can cause more damage:
If you are keeping your credit limits low on purpose, what you need to realize is that you are hurting your debt-to-credit ratio by making your collective balance appear to be a large chunk of your total available credit. Increment in the credit limit – or decline in balance – results in a more positive score for you.
So using the example given above, if one of your cards raised your limit by $1000, with your balances remaining the same, your debt to credit ratio will come down from 28 percent to 25 percent. On the other hand, if you were to cancel your card with the $7000 limit, without paying down on the other balances of $5000 to counteract the loss of credit limit, your new ratio will be 46 percent. Think about THAT!
Good info as always. Thanks for passing it along.