Why you should pay off your credit cards

• On 3:00 am EDT, Monday June 1, 2009

Perhaps you're among the millions of credit-card holders who have had their borrowing limits slashed over the past few months. And if it hasn't happened to you yet, brace yourself, because some analysts say credit issuers have more cutting to do.

Credit-card limits total approximately $5 trillion nationwide, compared with about $800 to $900 billion in revolving credit-card balances. Banking analyst Meredith Whitney, who predicted two years ago that banks would need huge infusions of cash to survive, forecast in March that over $2 trillion more in credit-limit cuts would happen within 2009 and $2.7 trillion by the end of 2010.

A cut to your credit limit can hurt your finances in several ways. It reduces your debt-to-available-credit ratio, which makes up roughly 30 percent of your credit score. And some card issuers have lowered credit limits to just above or even below customers' balances, triggering over-limit charges, which can run as high as $39.

In addition to slashing credit lines, credit-card companies have jacked up interest rates in the past year, and more increases are expected as banks try to clean up their tainted balance sheets and squeeze money out of their customers before new federal regulations that will curb some abusive card practices take effect in July 2010. Credit-card interest rates average about 13 percent now. In the 1970s and 1980s, when inflation was much higher, rates were often around 19.99 percent and many cards carried annual fees. Dennis Moroney, research director at the Tower Group, a financial services research company, believes that we may be headed back to that model and annual fees will be waived only when you charge a certain amount annually on a card.

Clearly it's in your interest to retire your credit-card debt as soon as you can. If you carry a balance on several cards, tackle the one with the highest interest rate first by paying more than the minimum. Since card interest rates are heading up, consider transferring a high-rate balance to a card with a low fixed rate. That's getting tougher to do since most cards carry variable rates and charge fees for balance transfers. But small banks and credit unions offer some deals. Credit unions, for example, can't charge more than an 18 percent penalty interest rate, compared with 30 percent for some banks.

Consumer Reports has no relationship with any advertisers on Yahoo!

Copyright © 2005-2009 Consumers Union of U.S., Inc. No reproduction in whole or in part without written permission.

Buzz up!