Consumer Law

How Your Credit Card Can Hurt Your Credit Score

By M. Stan Herring

USNews has posted an article that discusses how your credit cards can actually be hurting your credit score. If you have a credit card, such as a Visa Signature, World MasterCard or Amex Charge Card, that is set to No Preset Spending Limit (NPSL) it sounds like you can charge as much as you want to. Although not advertised by credit card companies, NPSL cards do have a limit and since most consumers don't know this it can hurt them in several ways.

There are two kinds of NPSL cards: charge and credit/charge "hybrid" cards. Most NPSL charge cards allow consumers to charge up to an undisclosed amount and require the balance to be paid in full each month. The charge/credit "hybrid" card has a set limit but encourages consumers to surpass the limit as long as they pay off the excess at the end of the month.

Even spending with credit cards like Visa and MasterCard is capped off at an undisclosed amount and if a consumer hits the limit their card will be declined. The same is true with NPSL cards, although credit card companies make it sound like there isn't a limit.

However, this does not represent the extent of the prospective danger for consumers inherent within current NPSL credit card offerings. The way in which NPSL cards are reported to credit bureaus can prove very detrimental to consumer credit scores as well. FICO -- the largest credit scoring agency in the United States -- calculates credit scores by considering numerous factors about people's credit history and current credit usage. One such factor is a balance-to-available credit ratio called credit utilization to which one's credit limit is obviously very important. But if the credit limits for NPSL cards are unknown, how is credit utilization calculated?

NPSL cards don't report the card's true limit to credit bureaus. Doing so would allow the limit to become public information and would then shatter the idea of not having a limit on the card. NPSL cards either report proxy limits, which is a changing credit limit or the highest balance held over a time period, or they don't report a limit at all. If the proxy limit is reported then credit utilization could reach 100% due to the credit card companies encouraging consumers to surpass the monthly limit.

If a high balance is reported then utilization will still be around 100% because spending doesn't normally fluctuate too much.

For instance, if you consistently spend around $2,000 each month, your highest balance will be close to that amount -- say $2500 -- and typical spending will exhaust most of your "available" credit and lead to your credit utilization being around 80 percent every month.

Theoretically, a consumer can mitigate the negative effects of credit utilization by adjusting spending to account for the way in which his or her card's limit is reported. If an NPSL card is reported as an open line of credit, credit utilization is left out of the credit scoring process and is therefore not a concern; if a card's revolving credit limit is reported, one could simply make sure to stay well below this amount; and if the high balance is reported, one could cease using an NPSL card altogether and move spending to a regular credit card. However, making such an adjustment would require knowing which type of proxy limit is reported for a given credit card, and according to the Card Hub study, no uniformity exists in how credit card companies report their NPSL options. Similarly, many issuers refuse to be transparent in disclosing their particular reporting methods.

NPSL cards can seriously damage your credit score. If you have had issues with your credit score or credit reporting errors, feel free to contact us through our website or by calling 205-879-2447.

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Full post as published by Alabama Consumer Blog on December 20, 2010 (boomark / email).