What Is a Credit Limit? How Does Affect Credit Score

what is credit limit
The Simple Dollar

If you’ve ever used a credit card or borrowed credit, you’re probably aware that you have a credit limit. But what precisely is it? A credit limit is the most money that a lender will let you spend on a credit card or line of credit. Knowing your limit, however, does not imply that exceeding it is a smart decision. In fact, understanding how to carefully manage your limit today will likely boost how much you can borrow later on for items like a home or a car. Here’s what you should know about a credit card limit and how to increase it.

What is a Credit Card Limit?

The entire amount of money you can charge to a credit card is referred to as the credit card limit. If your credit card has a $5,000 limit, for example, that means you can carry a balance on your credit card of up to $5,000. Your credit card limit applies to both new purchases and balance transfers, as well as any other transactions that rely on your credit line, such as cash advances. Even your annual fee is deducted from your total credit limit.

According to Experian 2020 data, the average credit card limit per American is around $30,365. This figure indicates the total credit available to Americans across all credit card accounts, not the per-card limit. Credit limits range from $2,000 to $10,000 per card in general, while many credit cards for those with weak credit provide lower credit limits in exchange for the opportunity to rehabilitate your credit score.

What Factors Influence a Credit Limit?

Lenders determine credit limitations. And there are other factors that could influence the decision. Companies may investigate your credit score, credit reports, and credit application. Here are some possible questions for lenders to consider:

  • History of payments: Do you pay your expenses on time, including your monthly credit card bills? Have you ever declared bankruptcy or had a debt forwarded to collections?
  • Accounts current: How many open accounts do you have? And what types of loans do you have available?
  • History of the account: How long have your current accounts been open? Have you recently applied for a lot of new credit?
  • Debt: How much debt do you have? How much credit do you have? How much money do you have?
  • Income: Do you earn enough to cover your monthly expenses?

If you are dissatisfied with your credit limit, you can request an increase. In some situations, your lender may decide to change your credit limit on its own. However, depending on the conditions, this could signify an increase or a decline.

How Is Your Credit Limit Determined?

One of three methods is used to determine your credit limit. In some situations, you will be given a limit. In other circumstances, your limit is determined by your credit history and credit score. Also, a credit card issuer will conduct a more thorough review of your credit history, taking into account any reasons why you might be a potential credit risk and calculating the credit limits you now have on your other cards.

The Credit-based Limit

Many credit card providers use your credit score to help establish the limit on your card. This means that your new card limit will be influenced by characteristics such as payment history, credit use, length of credit history, credit mix, and recent queries. Issuers will very certainly analyze your household income, employment, and monthly spending.

According to Bill McCracken, President of Phoenix Synergistics, a MarketTech company, the approach is identical to how issuers determine the interest rate on your credit card. If a credit card offer includes a credit limit range of $1,000 to $5,000, those with higher credit scores will receive the $5,000 credit limit, while those with lower credit scores will receive $1,000.

The Predetermined Credit Limit

Some credit card companies provide credit cards with fixed credit limitations. A beginning credit card might have a $500 limit, whereas a premium credit card might have a $5,000 limit.

“It’s not a very individualized decision,” Eric Lindeen, senior marketing consultant at CRM Northwest Inc., says. “If the limit appears to be unusually large or little, it is not a reflection of you as a consumer.” You simply applied for the incorrect card.”

What happens if you aren’t satisfied with the credit limit on your credit card? Lindeen proposes requesting a credit limit increase from the card company. Some issuers allow for some wiggle room, but he doesn’t expect an increase of more than 10% to 20%.

The Customized Credit Limit

Some credit card companies utilize a combination of characteristics to generate a unique credit limit for each new applicant. This allows credit companies to reduce risk while extending new lines of credit.

Some issuers, according to Lindeen, develop a grid system and compare several different types of ratings, such as a credit score and a bankruptcy score, to determine a credit limit. Others base a credit limit on your income or debt-to-income ratio. According to John Ulzheimer, a nationally respected credit expert who previously worked for FICO and Equifax, certain issuers may even consider the restrictions on your other credit cards, which may be seen on your credit reports.

Available Credit vs. Credit Limit

A credit limit is not the same as an available credit. If a borrower has a credit card with a $1,000 credit limit and spends $600, they will have an extra $400 to spend. If the borrower pays $40 and incurs a $6 financing penalty, their amount lowers to $566, and they now have $434 in available credit.

What Effect Does a Credit Limit Have on Credit Scores?

Your credit limit is closely related to your credit utilization.

Credit usage is the percentage of available credit that you use, and it is one of the factors that might affect your credit scores. Credit use should be kept under 30%, according to the Consumer Financial Protection Bureau (CFPB). According to the CFPB, the easiest method to keep that number low is to pay off your credit cards every month.

A bigger credit limit may enable you to spend more while maintaining a low use rate. However, with greater freedom and flexibility comes greater responsibility. Higher credit limits also make it simpler to accumulate debt quickly. It’s also crucial to understand that your credit score can be affected by a variety of circumstances.

What Happens If Your Credit Limit Is Exceeded?

A few things could happen if you exceed your credit limit. The first possibility is that your card will be refused when you attempt to use it.

According to the Office of the Comptroller of the Currency, you may also be charged a fee if you participate in an over-the-limit coverage scheme. However, that program is optional.

If you choose to participate in the program, you may be charged a fee each billing cycle that you exceed your credit limit. Before you opt-in, your credit card provider must inform you of the over-the-limit costs.

You can check your status by contacting your credit card company. And, if you accidentally opted in, you may change your mind at any time. However, you may still be required to pay any fees that have already been assessed. You may also be charged additional costs if your amount remains above your limit after you opt-out.

What to Do If Your Credit Limit Is Unreported

While a lender may disclose your account activity to credit agencies, it may not reveal your credit limit. And, because credit limits can have a favorable impact on your credit ratings (especially if they’ve increased or you’re using less than 30% of your limit), you’ll normally want your lenders to report your limits to the bureaus. Here are some options to explore if you have an undeclared credit limit.

  • Request the reporting of a credit limit. Call your card issuer’s customer care to see if the company has changed the way it reports your card. Remember those card issuers are not compelled to report to the bureaus, but it never hurts to inquire.
  • Consider getting a new credit card. Consider creating a new credit card if the card that isn’t reporting a limit is one of only a few credit accounts on your reports and you’re in a position to take on some additional credit. Make sure you choose the finest credit card for you and that the issuer reports your credit limit to the credit agencies. Keep in mind that opening a new account may lower your average age of credit and will add a hard inquiry to your credit reports, potentially lowering your credit ratings.
  • Reduce your use of the card. While you should not necessarily shut down your credit card account, it may be prudent to use your card less frequently while keeping it active in order to reduce your overall credit utilization rate.

The Benefits and Drawbacks of Credit Limit Increase

Credit limitations do not usually remain constant during the life of your account because your finances vary over time. It’s a good idea to consider whether it’s a suitable time to request a credit limit increase. If you’ve recently received a raise, have good credit, or have a track record of making on-time payments, you may be poised to request a credit increase.

However, before you request a credit limit increase, there are some factors to consider.

Pros of a Higher Credit Limit

  • It gives you more budget flexibility.
  • If you don’t carry a balance, it will reduce your overall credit utilization ratio. Additionally, decreased utilization will improve your credit score. It’s a good idea to calculate that ratio before you start the talk.

Cons of Increasing your credit limit:

  • It permits you to spend more money and potentially accumulate debt that is difficult to repay.
  • The credit check that is frequently done to establish eligibility may harm your credit score. Inquire with your card company about increasing your credit limit without a hard inquiry.
  • If you decide to forward with the request after assessing the benefits and potential drawbacks, you have several options for requesting a credit increase. The simplest method is to simply ask, which is normally done via your online banking interface or via phone.

Conclusion

Credit cards are one instrument that can be utilized to establish credit or generate financial flexibility if used wisely. And part of being responsible with credit is knowing what your credit limit is and making on-time payments every month.

But that’s only the beginning. Understanding how your credit card works might also assist you in using it wisely.

Credit Limit FAQs

What is a good credit limit amount?

According to Experian, a healthy credit limit is greater than $30,000, which is the average credit card limit. A credit limit this large usually necessitates a great credit score, a significant income, and little to no existing debt. However, what constitutes a good credit limit varies from person to person.

How does a credit limit work?

A credit limit is a maximum amount you can charge on a credit card or other revolving credit account. The amount of each purchase is deducted from your credit limit as you use your card. The resulting figure is known as your available credit.

What is a minimum credit limit?

The minimum credit limit refers to the amount of credit that the bank will grant you on your application.

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