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.
Are you getting your phone out now?