Tighter credit limits hamper mortgage chances

CHICAGO — If you plan to wait out this housing downturn, intending to buy a home when the coast is clear, you better start checking your credit reports now. There may be some surprises.

Credit-card companies are reducing credit limits on some borrowers. For some people, that may cause a drag on their credit score.

Here's why: A major factor in calculating a person's credit score is credit utilization, said Barry Paperno, consumer-operations manager for Fair Isaac's myFICO division.

When your total available credit shrinks, the percentage of credit being used goes up, and that has the potential to damage your credit score.

"That will become a problem for some consumers, and it's something that they need to be paying close attention to," said Steve Ely, president of Equifax Personal Information Solutions. Equifax is a credit-reporting agency.

A good credit score is necessary to get the best loan rates. For more than a year, lenders have been requiring higher scores as mortgage-underwriting standards tightened.

Credit-card companies also want to control their risk; that's why they're reeling in credit limits, said Andrea Ayers, president of customer management for Convergys, a customer-service firm that works for card companies.

If your credit limit is cut, it might be difficult today to change the lender's mind.

In addition to cutting limits, companies have been making changes to interest rates and fees. They're also reaching out earlier to borrowers when they have missed a payment, using a "soft touch" to help them create payment plans soon after the due date has passed instead of waiting a month, Ayers said.

Not everyone is seeing their credit disappear. To determine where to make changes, companies look at customers' credit scores and their track record for paying bills on time, Paperno said.

They also base decisions on their experiences with people who have similar credit scores, he added.

If, say, a company's data shows that people with FICO scores of 710 or less have shown a higher pattern of risk lately, someone with a 700 score could be affected, he said.

Unfortunately, that creates the possibly of a consumer experiencing a "snowball effect," which could push the score down even farther, he said.

"Let's say lender 1 reduces your limit because it's tightening up on credit exposure. Your score drops," he said. With that lower score, "lender 2 is going to lower your credit limit," pushing your score down even more, he said.

This scenario hasn't played out very much yet because there is some lag time, Paperno said. It takes time for a credit reduction to be reflected in a score, and it would take additional time for a second lender to react.

Those with credit accounts that haven't been used in a while might also be affected, said Cate Williams, vice president of financial literacy for Money Management International, which operates credit-counseling agencies.

"They granted you a product and they want you to use that product. And if you're not using a credit card, I could see the credit cards saying 'If you're not interested, we're not interested in keeping this on our books,' " she said.

If you plan to buy a home in the next year, there are some things you can do to keep your credit looking as good as possible.

• Check your credit report. Find out if there have been changes to your account limits, and make sure there aren't any errors. Look for any negatives on your report — many negative items should be removed after seven or 10 years.

• Don't get close to card limits. About 30 percent of your FICO is based on the ratio of the amount owed on active cards to your available credit.

But utilization on individual cards is important, too. Getting close to the limit on one card will also reflect negatively on your score. Pay down balances as much as possible.

• Keep accounts active. Accounts get closed when there hasn't been activity for a while. Make small purchases on cards a couple of times a year — then pay them off right away — to keep accounts active and your available credit up.

• Pay bills on time. This should be easy but could prove challenging for people who could lose their jobs in the months ahead. Be proactive and contact the credit-card company as soon as possible if you're having problems paying your bill. Payment history counts for about 35 percent of your credit score.

• Don't apply for new cards. Store cards are tempting when they offer discounts at the register, but don't bite. Applying will have a negative effect on your score in the short term.