How Does a Credit Limit Work?
Published: January 26, 2022
Revised: May 25, 2022
What is a Credit Limit?
A credit limit is the maximum amount your lender will allow you to borrow using revolving credit such as a credit card or a line of credit.
Let’s assume you are approved for a credit card with a $5,000 credit limit. This means you have $5,000 available to spend on the credit card. Once you start swiping your credit card for purchases, the amount you spend is deducted from the credit limit.
For example, if a credit card has a $5,000 credit limit and you spend $500, your available credit limit drops to $4,500. But, when you make a payment for $300 towards the balance of your credit card, then your available credit increases to $4,800.
As you spend or make payments, the available credit will fluctuate but the maximum credit limit will remain the same.
How Is Your Credit Limit Determined?
For your lender to issue your credit limit the following factors must be determined.
- Your Credit Score: A number ranging from 300 to 850 and represents your credit worthiness. Based on five financial factors, your credit score is used to help lenders determine your risk level as a potential borrower.
- Your Payment History: Lenders will look at your payment history to determine if you have a pattern of on-time, late, or missed payments to determine your credit limit.
- Your Income: How much income you earn will have a direct impact on your credit limit. Lenders need to be sure your income covers the monthly payments on your credit card if your entire credit limit was used.
- Your Current Debt Amount: The amount of debt you currently carry in relation to your current credit limit is known as your credit utilization. A higher credit utilization is considered higher risk for lenders and will affect your credit limit amount.
Credit Limit and Your Credit Score
Your credit score is made up of five separate factors:
- Payment history
- Length of credit history
- New credit
- Credit mix
- Credit utilization
As mentioned above, credit utilization is the amount of debt owed compared to the credit limit. For example, a credit limit of $1,000 with a balance of $300 has a credit utilization of 30%.
A good rule of thumb is to keep the credit utilization below 30%, however MyFICO recently reported that those with a credit score of 785 or higher had a credit utilization of 7%.
How to Increase Your Credit Limit?
If you currently have maxed out credit cards, requesting a credit limit increase may not be your best financial move. Also, most lenders will be hesitant to increase your credit limit if your credit utilization is already high.
However, if you're looking to increase your credit limit because you have a recent increase in income or you want to improve your credit score by lowering your credit utilization with a credit limit increase, then asking for a credit limit increase may be a great move.
Increasing your credit limit is very simple — just call your card issuer and ask. Many lenders also have the ability to request a credit limit increase online and you can potentially be approved in a matter of minutes.
Keep in mind, some lenders will perform a hard-inquiry pull on your credit which may initially lower your credit score.
What Happens if You Go Over Your Credit Limit?
Most often if your card is charged beyond the credit limit, your transaction will be declined.
However, there are some instances where your spending could possibly extend beyond the credit limit maximum. When this happens, you can expect to pay an over-limit fee. Then, in addition to the fees, your rates could also go up and your credit score could be negatively affected.
Final Thoughts on Credit Limits
Although your credit limit is an important number to know and understand, credit utilization should be the focus.
Always try to maintain a credit utilization of 30% or less in order to maintain a good credit score. If increasing your credit limit lowers your credit utilization, then asking your lender for a credit limit increase may be a great financial move. However, if the motivation for pursuing an increased credit limit is so you can spend more and increase your debt level, then push pause on asking for a credit limit increase.
Chris “Peach” Petrie is the founder of Money Peach. Money Peach partnered with OneAZ to provide free financial education to members across the state. To learn more about OneAZ’s partnership with Money Peach, click here.
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APR = Annual Percentage Rate