When your new credit comes in the mail you’re given a paper listing your credit limit. Every so often, if you’re a good borrower, you can increase your credit limit. However, have you ever wondered how this credit limit is even decided?
The method used by credit card companies to determine your credit limit is called underwriting. Underwriting works via mathematical formulas besides testing and analysis. But, the exact details of how this works is kept tightly under wraps by each institution since it’s how these companies make their money.
In this article, we do our best to shed some light on credit limits, how they’re determined, and your credit limit is affected by your credit score.
What Is A Credit Limit?
Simply put, a credit limit is the maximum amount of money you can spend on your credit card. While a high limit allows you to purchase more expensive items, offers you more flexibility, and can improve your credit score, it can also get you into trouble easily if you get buried in credit card debt.
How much of your credit you use determines a portion of your credit score. It’s wise to have more available credit than you’re using to keep your credit score high.
While most Americans have credit cards, few of them think much about their credit limit, which is one reason so many of them get into trouble with their credit cards. Fortunately, it’s easy today to get a handle on your credit limit with the many apps available that assist you in managing your credit cards.
If you don’t have a smartphone or prefer not to use an app to achieve this, you can use the card issuer’s website to get this helpful information. Most of these sites will give you your balance and your limit at a glance so you know exactly where you stand.
If you don’t have access to an app or a website, you should be able to find this information on your statement each month.
How Are Credit Limits Determined?
Stated by a credit repair company in Austin, when a company sets a credit limit, it’s a sign of how much they trust the borrower to pay back what they owe. If you’re given a high limit, it means the bank thinks you’re low risk and are likely to pay off your debt and make timely payments. You’re considered a good borrower.
However, if you don’t look like a low-risk borrower to the bank, they’ll give you a low limit to start. If you pay your debts responsibly, the banks or card issuer may raise your limit after a set time. After some time, you can also request to increase your credit limit, if need be.
The Role Of Credit History
A major determining factor in your credit limit is your credit history. When you apply for a credit card, the card issuer checks things like your annual income and your credit report to determine what your limit will be.
When they look at your credit report, they factor in your repayment history, your credit history length, and how many credit accounts you have open. Open credit accounts include other credit cards, mortgages, student loans, auto loans, and personal loans.
Card issuers also look to see if you have any derogatory information on your credit report. Bad marks on your report could be things like bankruptcies, missed payments, late payments, tax liens, or accounts that have gone into collections.
Other Items That Factor In Your Credit Score
While the underwriting process is different depending on the company, many consider identical variables in determining your limit. Some items they consider are the credit limits on your other accounts and your work history.
Your debt to income ratio also plays a role. If you have a lengthy work history and low debt to income, you’ll be seen as low risk and most likely be given a higher limit.
If you apply for a card and don’t get the credit limit you were hoping for, it’s most likely something in your credit report that’s holding you back. That’s why it’s a good idea to check your report regularly to know where you stand and what you can do to improve your credit score.
How Do Credit Limits Affect Credit Scores?
While credit card limits affect how much purchasing power you have, they also directly impact your credit score. One of the ways it does this is mentioned above in your credit utilization ratio or known as debt to credit ratio. This ratio is important as it comprises 30% of your FICO credit score.
People with low credit limits get into trouble easily with credit utilization, which is why it’s best to strive for higher limits. If you have high credit utilization, it reflects poorly on your credit score.
Remember that every credit report is different, and just because you brought your ratio down and it reflects positively on one report, it doesn’t mean it’ll do the same on another.
Still, it’s wise to keep your credit utilization ratio low when possible. How low? Well, many experts say under 30% is a good number to aim for.
A good way to increase your score and lower your credit utilization ratio is to ask for an increase in your credit limit but keep your card usage the same.
What About Going Over Limit?
We probably don’t have to tell you this, but going over your limit is a bad move. Going over the limit takes your credit utilization to over 100%, and that’s a bad place to be in.
Most items, your credit card company will just deny the transaction that puts you over your limit, however, some don’t. Some card issuers allow users to opt into an over the limit coverage whereby they pay a fee if they go over and the card issuer honors the transaction.
Still, even if you have this protection, it’s best not to go down that road.
Besides hurting your credit, going over the limit puts you at risk for having your limit decreased or your account closed by the card issuer. Also, being over the limit may cause your card issuer to increase your interest rate. So, avoid going over whatever you do.
It’s important to understand how credit limits work and how they impact your credit score. Equally important is staying on top of your credit score to know where you stand. There are many apps available right from your smartphone that let you access your credit score and show you where you need to improve.
The New York Federal Reserve report recently shared a chart that does not bode well for young millennials. It showed a trend of 18-29 year-olds who are more than 90 days delinquent on credit card payments.
This can be concerning for a few reasons; one, because the millennial generation has been traditionally known up to this point as being debt-averse and critical of banks and creditors. The millennial generation grew up watching their parents struggle during the Great Recession that ravaged the US economy during the late 2000s.
Economists believe that this was the genesis for the millennial generations’ distrust in banks and reluctance to take on credit card debt. In fact, between 2008 and 2012, only 41% of adults in their twenties even had a credit card.
The point is that up until very recently millennials have been cautious with their money and typically responsible with credit card debt if they even had any. But that is not the only concerning factor to this growing trend.
Having credit card debt is one thing but not having any means to pay it back is a much more alarming notion, but that is the reality that many millennials are facing. Just a few years ago, the millennial unemployment rate was at a staggering 12.8%. It is even grimmer when you compare that number to the 4.9% of other eligible age groups that were unemployed at the same time.
The US economy has put the Great Recession behind it and has been experiencing growth for the last decade, so the jobs are out there. The problem is that millennials tend to have higher expectations when it comes to getting a job.
Millennials often get looked at as a remarkably entitled generation of people, and this reflects in the way they select jobs. Many job offers are turned down by members of this generation because they were expecting a higher pay rate even in comparison to their lack of experience.
Education may have something to do with the millennial unemployment rate as well. Many companies are reporting that the upcoming workforce is lacking in real-world skills like critical thinking and basic communication. Millennials are also more likely to have gravitated towards theoretical studies in their college educations, which doesn’t help the situation much.
This lull in employment could not have come at a worse time for millennials either. It is generally agreed by people of the previous generation that it is much harder to get started in life financially these days than it was for their age. Part of this has to do with the increasing cost of higher education, so student loan debts are higher than ever.
This creates a vicious cycle for millennials in terms of job prospects. For example, a fresh-faced college graduate may open a line of credit to help furnish a new apartment with the hopes of landing a job soon. Maybe he also has a significant amount of student loan debt. Things are shaky as he or she is first entering the job market, and a combination of high expectations, mounting debt and lack of real-world skills are making it difficult to land a job.
So their credit scores are taking a nosedive and guess what: some companies will actually look at a candidate’s credit score and factor that into their decision to hire or not.
What is Contributing to Millennial Credit Delinquency?
Seeing a generation traditionally wary of credit card debt and realizing that it is harder for them to get a job are both bad omens but there what is causing the actual rise in delinquency among millennials?
One of the most immediate contributors to the increasing amount of millennial credit card debt is raising rates. In 2018 interest rates were at a staggeringly low level but they are beginning to rise again, meaning that even people with good credit are facing interest rates of 18-25%.
Student loans are another factor in this trend. The prior generation had the benefit of much more lenient crediting when it came to student loans with significant banks offering specialized student credit cards. These student credit cards were relatively easy to come by, but the Credit Card Accountability Responsibility and Disclosure Act (also known as the CARD Act) of 2009 changes all that.
Now students have to show proof that they will be able to pay back student loans or at least evidence that their parents would help them. This has resulted in millennial students taking high-interest loans for their education, which can be challenging to claw one’s way out of.
This all sounds like a financial emergency, but it is crucial to keep things in perspective. Even with a rise in millennial credit card delinquency the debt-to-income ratio as reported by the Federal Reserve is the lowest it’s been since 1980. Delinquency rates have also been at a record low in the past year, so we are nowhere near a financial crisis even with this uptick in millennial payment delinquency.
Many millennials are just starting to build their credit and hit the job market, so this is not necessarily a trend that will continue. While all young adults should be careful and responsible with credit card debt, the recent Fed report should be more of a precautionary tale than the harbinger of an all-out crisis.
So, you applied for a credit card and you were approved. You’ve been granted a maximum limit of $2,000 – Perfect! There’s a pair of shoes you’ve had your sights set on for months. After all, isn’t that why you need a credit card? You swipe your shiny new card and are beyond ecstatic with your killer new shoes. Virtually overnight, you’ve maxed out your credit card. You’re completely baffled.
How did this happen?
You’re now responsible for paying off borrowed funds and available funds in your checking account won’t be enough to cover the balance.
Like many people, you decide to apply for another credit card, so you can pay your bills and keep your head above water. This is certainly no way to live.
What do you do? This feeling can be overwhelming and believe me, there are tons of people who have encountered the same problem. You will need to repair your credit score and get your credit card bills down, but when you have obligations every month that conflict with your minimum payments, it may seem harder than you realized to accomplish these goals. Facing this challenge will require you to start planning.
I’m sure that plenty of people throughout your adulthood have offered advice surrounding the importance of budgeting your income. And like most people, you immediately assumed that these individuals had no clue what your situation entailed.
Everything is easier said than done, right? While creating a budget and sticking to it is undoubtedly difficult, getting into a healthy financial routine will help you successfully manage your credit card spend.
Create a Budget
First, it’s important to acknowledge and firmly understand what you can and cannot afford. Take some time to examine your monthly income against your expenses and purchases to determine if you are spending more than what you’re bringing in.
By doing this, you’re just setting yourself up for disaster. And it’s certainly not good if you are only paying the minimum on your credit cards or even less, only because you cannot afford the monthly payments.
This means you need to start adequately planning for your monthly expenses so you can settle your debt and erase bad spending habits moving forward.
It’s important to prioritize. Of course, enjoying a meal at your favorite restaurant with friends or treating yourself to some new clothes is fun, but if your monthly income can’t accommodate these additional expenses than you need to focus on covering the necessities. Don’t let yourself dive into a black hole of lousy credit just for a few nights of cocktails.
Once you come up with a budgeting plan and eradicate your debt, you’ll be able to set aside funds as needed for these special occasions.
Create a Spreadsheet
Staying organized is a crucial factor in tackling what you owe on credit cards and how you should be managing your monthly income. A great way to do so is to create a spreadsheet. While this may seem like a tedious task at first, you will find that when you clean up the clutter, you will be able to become more successful at managing your bills.
A spreadsheet will help you put everything into perspective, essentially laying out all the numbers in one place. If you have three credit cards, a student loan, utility bills, and monthly rent payments, that’s a lot of moving parts to be responsible for. And you could find yourself panicking over attempting to shuffle it all together in your mind.
By putting it all in front of you, you will have gained a more realistic perception of your financial situation, and you will finally be able to break away from shouldering the weight of your debt.
Look For Good Benefits
Another tip with credit cards is being sure to get a credit card that has benefits. There are plenty of credit cards in the marketplace that you can choose from, and you should select one that best fits your needs. Many credit companies provide cashback incentives or sign-on bonuses that you should undoubtedly research and take advantage of.
You can either use the money that you earn back to help pay off your credit card or use it to pay off other bills.
If you have a credit card that comes with a high-interest rate or an annual fee, there is often the option to transfer your balance over to a credit card with a lower interest rate and no annual fee. The problem with interest rates is that a lot of times if you are paying the minimum per month then you could be mostly spending your hard-earned pay on interest and be forced to prolong your payments when you could have been finished paying off a credit card at an earlier time.
Set Payment Reminders
Also, make sure you set alarms for yourself. When I say this, I am talking about when to pay your bills every month. We are all human with busy schedules, and sometimes we forget deadlines. The problem with that is that you could run the risk of a bill stacking up and penalties caking on.
Also, not paying your credit card bills on time could negatively impact your credit score, which will only make things harder for you moving forward.
It can certainly be a little overwhelming when you think about trying to tackle a battle such as getting your credit card spending in check. You may feel that it is impossible, but understand it is a journey that will take time. By being dedicated and disciplined to staying organized and being financially responsible, you’ll find yourself having a much easier time covering your expenses.
Once you get to that comfortable playing field, it will no longer feel like budgeting and instead, feel natural.