Your Credit Score may take a hit if Card issuer lowers Credit Limit

As people’s cash flows got impacted due to the lockdown, credit card companies started evaluating creditworthiness of their customers. As a result, many cardholders saw the issuers lowering their credit limits in April and May. What many cardholders didn’t realize is that the lowering of the credit limit could impact their credit score if they have an outstanding balance on their cards. When calculating credit scores, the credit bureaus look at several parameters. One of the key parameters is the usage of cards compared with the credit limit available. This is called credit utilization.
Wilfred Sigler, Director—Sales and Marketing at CRIF India—a credit bureau— explains: “Credit utilization, sometimes called a credit utilization ratio, is the ratio of credit card outstanding to the credit limit. It can impact up to 20-30% of a credit score, depending on the scoring model being used."

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, if the credit limit is ₹1 lakh and the customer has an outstanding balance of ₹80,000, the credit utilization ratio will be 80%. If your credit limit was cut recently and you have an outstanding balance, your credit utilization will shoot up. Take an example of someone who had ₹4 lakh credit limit and has an outstanding balance of ₹50,000. The credit utilization ratio in this case was 12.5%. But if the issuer reduces the credit limit to ₹75,000 and the outstanding remains the same ( ₹50,000), the credit utilization rate will be 66.67%.In April and May, when the issuers reviewed their portfolios, many users saw the credit limit fall by up to 80% (to know more read here If these users have an outstanding on their cards, their high credit utilization will impact their credit score.

What should you do?
If your credit card limit is reduced and there’s an outstanding balance, an individual must repay the dues to lower the credit utilization. “A high credit utilization ratio indicates that the cardholder is in a cash crunch consistently or is a compulsive spender," said Sigler. As you bring down the outstanding balances on cards, your score would improve if it was impacted. According to credit bureaus, individuals should keep the credit utilization ratio of 30% or below. The preferred credit score varies from lender to lender. Public sector banks, typically, offer loans to those with a credit score of 700 or more. Private banks have a higher score requirement. Non-banking financial companies accept applications with a score even lower than 700. 

If you are planning to take a loan, a lender would also look at other parameters, besides credit score, to evaluate your application. “One of the key things that lenders look at is a parameter called fixed obligation to income ratio (FOIR). Under FOIR, a lender considers the applicant's fixed obligations such as current equated monthly instalments (EMI) to determine eligibility," said Ashish Singhal, managing director, Experian Credit Information Company India, a credit bureau.
If a person’s net monthly salary is ₹1 lakh and EMIs on different loans total ₹30,000, the FOIR will be 30%. A lender would still be comfortable lending to applicants who have a low FOIR. “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 Singhal.

Source: Publication: Livemint |18th June 2020