No-limit credit cards could lower your FICO score
One very important part of your FICO score is what's called your utilization ratio. That's the percentage of your available credit that you're using during any given period. For instance, if you have a credit card with a $10,000 limit and you have a $2,500 balance, you have what many experts would consider to be an ideal ratio. But if you have a $10,000 credit limit and you're maxed out, you look like a riskier customer. The result: A lower score.
So if you have a card with a set limit and you keep your transactions and balances to around 25 percent of that limit, you're golden. But some cards out there don't have preset spending limits, and this is where things can get tricky, according to Barry Paperno, consumer operations manager for FICO.
Charge cards, for which you have to pay off the balance in full every month, don't have preset credit limits, but since they're what the industry terms "open" credit instead of "revolving" credit, the lack of a limit can't drag down your score. But credit cards that don't have preset spending limits are another story.
"These no preset spending limit accounts are somewhat of a hybrid," Paperno explains."They have a credit limit and up to that limit, they behave like a credit card, but it also allows you to exceed the limit. The amount you exceed it by is due in 30 days just as a charge card would require." As a result of this dual nature, it's up to the issuers to decide if they want to report these cards as charge cards or as credit cards.
If they report them as charge cards, your score won't take a hit. But if they report them as credit cards, you could lose out. "If there's no limit, the score will look to the 'high credit amount,' which is typically the highest the balance on that account that has ever been, or has been within a certain period of time," Paperno explains.
In other words, if you charge a similar amount every month on that card -- whether it's only a hundred bucks or several thousand -- it's going to record your balance and your limit as being the same, which makes it look like you're maxed out. For purposes of your credit utilization ratio, this is killer. How much it could drag down your score depends on a slew of other factors like how many cards you have and what their credit limits are, but it could ding you significantly if you rely on this card as your primary one.
This is one of the (many!) reasons why it's so important to be familiar with your credit report. We've said it before, but it bears repeating: You can get your credit report once a year for free by going to annualcreditreport.com. Haven't gone there in a year (or ever)? Go do it now!