Whether you’ve had credit troubles or not, the offer of a credit card with no spending limit might get you thinking. On the one hand, it’s an obvious opportunity to build up your credit card debt to truly unmanageable levels. On the other hand, wouldn’t it be a relief not to have to worry about whether you have enough credit to handle any emergency?
You might assume that these offers are made only to people with very high credit scores. That’s likely the case, although banks often make credit card offers to people with low credit scores — even those who have just emerged from bankruptcy.
These credit cards — what banks call no preset spending limit (NPSL) cards — sound like a good thing to have in your wallet, if you can afford the risk. A recent study by CardHub.com, however, says there’s a good reason to be wary, however. It turns out that just having one could ruin your credit score, even if you stay well within your budget.
What is your credit utilization if you have a no-limit credit card?
The problem with NPSLs, analysts say, is in the way the credit bureaus calculate your credit score. According to FICO, which calculates credit scores, almost a third of your score is largely determined by “credit utilization.” Credit utilization is the percentage of your available credit that you are using and, generally, the lower that percentage the better for your credit score.
Imagine for a moment that the only credit account you had was a $1,000-limit credit card. If you typically carried a balance of $200, your credit utilization ratio would be 20%.
The problem is that without a limit there is no way to calculate the credit utilization ratio. If there is no credit limit reported, FICO says, it will essentially consider the highest balance you’ve ever carried on that card as the credit limit.
In other words, suppose that you replaced that $1,000-limit credit card with an NPSL, and you still carried a balance of $200, which you’ve never exceeded. FICO would consider your credit limit on the card to be $200. Your credit utilization ratio would now be 100%.
Although there were variations, overall CardHub found that NPSL cards do tend to drag down the FICO scores of those who carry them.
The CardHub study also found that “no preset spending limit” does not mean unlimited spending power. Because NPSL cards lack the predictability of ordinary credit cards, consumers may find themselves declined at the point of sale when they try to make a large purchase. So much for knowing you could cover any emergency.
NPSL accounts are also harder to manage, the study found, so it’s easy for consumers to get into trouble even if they don’t overspend.
“Consumers who use these cards are not able to manage their accounts the way they can with traditional credit cards, making them vulnerable to hits in their credit scores,” the study’s authors wrote.
Whenever you consider opening a new credit account or taking on credit card debt, it’s essential to weigh the benefits and the risks. According to CardHub, for most people, an NPSL credit card is simply not worth it.
Source: ConsumerAffairs.com, “No-Limit Credit Card Might Not Be Such A Good Deal,” Mark Huffman, January 31, 2011