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Credit limit: How lenders assess your credit quality

Learn how your credit limit can be a powerful tool or a financial trap.

Author Justin Cupler
Contributing Writer at Tally
Updated: October 2, 2020

When you get a new credit card or line of credit, there are plenty of numbers to remember: interest rates, rewards points and available credit are just a few. You also need to know your credit limit.

A credit limit is the maximum amount of money you can charge to a revolving credit account, which could be a credit card or a line of credit.

We’ll review why it’s crucial to understand your credit limit and how it affects your credit score. But first, let’s look at how your credit limit differs from other restrictions on your credit card or line of credit. 

Credit limit vs. available credit

A credit limit is sometimes confused with available credit, but they’re not the same thing. Your credit limit is the total amount you can charge on a card or a line of credit. Available credit is the credit limit minus the balance you carry on the account. 

For example, if your credit card has an $8,000 credit limit and you make a $2,000 purchase on it, your available credit is now $6,000. 

Credit limit versus cash limit

Aside from a credit card limit, many credit cards come with a cash limit. This is the amount of cash you can withdraw using your credit card. Usually, the cash limit is significantly lower than your credit limit (about 20%-30% of the total credit card limit). Your cash limit may also come with multiple fees and a higher interest rate, so exercise caution before withdrawing money. 

How a lender determines your credit limit

Smiling man on phone while using his credit card to shop online

When you apply for a credit card, the lender pulls your credit history and assesses your creditworthiness. This not only determines whether you get approved, but it also helps set your credit limit. 

A lender looks at multiple credit factors, including your credit score and payment history. If your credit score is low or you’ve made late payments in the past, a lender may offer you a lower credit limit. 

Credit card issuers will also look at your credit utilization ratio, which is the percentage of your credit limit you’ve used on your existing cards. 

For example, if you have a credit card with a $5,000 limit and a balance of $2,500, you have a 50% credit utilization ratio. The higher your credit utilization ratio, the greater the risk to give you another credit card. As such, the lender may offer you a lower limit or decline your application.

On the other hand, if you have a good credit score, no late payments and a satisfactory credit utilization ratio, the lender is more likely to offer you a higher limit.

Every lender has its own set of rules that govern credit limits, so while one card may offer you a $1,000 limit, another may offer you $5,000.

How your credit limit impacts your credit score

Lenders report your credit limit to the three major credit bureaus: Transunion, Equifax and Experian. While your credit limit doesn’t affect your credit score directly, it does play a role in it. 

Where the credit limit comes into play is your credit utilization ratio. Your credit utilization ratio falls under FICO’s “amount owed” section and accounts for 30% of your credit score

To minimize its negative impact, you want to keep your credit utilization ratio under 30%. The lower the utilization, the higher your credit score goes. 

If you have a $5,000 credit card with a $2,500 balance, your credit utilization ratio is an unfavorable 50%. 

But if you open a new credit card with a $5,000 limit, your utilization ratio falls to 25%, which may improve your credit score because it’s under the 30% credit utilization threshold that FICO prefers. 

What happens if you exceed your credit card limit?

Confused woman who has exceeded her credit limit

Before the Credit Card Accountability Responsibility and Disclosure Act of 2009, credit card companies would often allow you to charge beyond your credit limit and hit you with an over-limit fee. These fees were typically between $20 and $40, regardless of how far you went over your limit.

The 2009 law prohibited credit card issuers from charging this fee unless the person opted in when signing up for the credit card. As expected, virtually no one opted into this fee, despite some credit card companies marketing it as a way for customers to avoid embarrassing declines at the cash register. 

Still, there are several actions your credit card issuer can take if you go over your credit card limit, including: 

  • Declining the transaction
  • Changing your payment date
  • Lowering your credit card limit
  • Increasing your interest rate
  • Closing the credit card
  • Voiding credit card rewards
  • Increasing your minimum payment

Can you request a credit card limit increase?

Once you’ve established history with a credit card company, you may be able to increase your credit card limit. Each credit card company has its own process for increasing credit limits, but most will allow you to request this online or over the phone.

To determine whether or not you qualify for an increase, the credit card company will make a soft or hard inquiry on your credit report to determine your creditworthiness. The credit card issuer may also ask for updated employment status and annual salary when assessing your qualifications. 

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Here are some pros and cons to requesting a credit card limit increase:

Pros

  • May decrease your credit utilization ratio, thereby improving your credit score
  • More room to take advantage of rewards points
  • Additional room for 0% balance transfers

Cons

  • Temptation to rack up more credit card debt
  • Requires a good credit score
  • May require a hard inquiry on your credit report, which can negatively impact your credit score

Lenders can change your credit limit without you asking

When you sign up for a credit card or line of credit, you give that lender permission to check your credit and adjust your account periodically. A lender won’t perform a hard inquiry, which can impact your credit score. Instead, it’ll perform a soft credit pull that allows it to review your balances, payment history and credit score. 

If there have been unfavorable changes to your credit report, including late payments, high credit utilization or a lot of inquiries, the lender may lower your credit card limit to protect itself. You likely won’t know about this reduction until you check your credit report or get a notification from the lender in the mail. 

On the flip side, if your credit has improved since you signed up for the credit card or credit line, the lender may give you a higher limit in an attempt to get you to spend more. Like a credit reduction, you won’t always know about this higher credit card limit or credit line increase until you check your credit report or receive the notification in the mail. 

Understanding your credit card limit can help you improve your financial status

Your credit limit is a balancing act

A credit card limit is a delicate balancing act. Too low of a limit can negatively impact your credit score, but a high credit limit can tempt overspending. With a firm understanding of your credit card limits and their impact on your credit score, you can make them work to your advantage and get closer to your financial goals.

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