A credit limit is the maximum amount of money a lender offers to a borrower. Whether it’s in the form of a credit card, home equity line of credit, or other kind of revolving credit account, there is a maximum amount of money available to the borrower, and that amount is his/her credit limit.
The lender sets a credit limit when extending the offer of credit to the borrower. This will be based on the borrower’s income, credit score, payment history, and other factors included in the loan application.
Loans that have collateral, like a mortgage or a home equity line of credit, will use the borrowers income and the value of the property or the remaining home equity to set the credit limit for the account. This article however pertains to credit card accounts versus other types of loans.
Credit Limit vs. Available Credit
Credit card debt is “revolving” debt, meaning the amount revolves around how much you use and paydown monthly. You have a limit to the amount of funds you can use on a particular credit card account. A card with a $5,000 limit for example means that is the maximum amount, at any given time, that you can utilize. Available credit is how much of your credit limit is still available to you after factoring in what you’ve already used. So on a $5,000 credit limit, if you spend $3,000 on that credit card, you’ll have another $2,000 left over in available credit. If you paid down by $1,000, you’d have $4,000 available.
When Your Credit Limit Changes
A creditor may increase your credit limit if you have a good payment history and have not maxed out your borrowing. This is a good thing for your credit score, because part of your score is based on your utilization rate. It can also be risky to have an increased limit if there is a danger that you will increase your borrowing to match. As long as you don’t have a spending problem and continue to pay off your credit card debt diligently, an increased credit limit should be welcome.
There are some cases, however, where your limit could get so high that you will look less attractive to lenders. If you have a total credit limit that is much higher than you could afford to repay or if you maxed out all of your credit, then lenders are unlikely to extend additional credit. If you’ve got more credit available than you earn in a year, then you might want to ask your existing creditors to lower your limits so you present a lower risk of default to new lenders.
There are circumstances when the creditor may reduce your credit limit even if you don’t ask them to. If you are late with payments, or exhibit behavior that makes it look like you might default on your account, the creditor might lower the limit to reduce they could potentially lose if you stop paying. Having your credit limit reduced in this way will certainly be bad for your credit score, and might put you at greater risk of defaulting or going over your credit limit.
Going Over Your Limit
It used to be common practice for credit card companies to let people over-spend and exceed their credit limits. The benefit to the borrower was that the transaction would not be declined at the cash register. But creditors charged standard “over limit” fees for every billing period when the account exceeded the credit limit. That fee was typically something like $35, added to your credit balance—making you go even deeper in debt. On top of that, going over limit could trigger a penalty rate, which would increase the interest rate paid toward the debt, and you might lose any credit card rewards you had built up.
It was common for people to be trapped in a cycle of fees, because the over limit fee itself could push them back over the limit. This kind of thing became such a problem that new laws were passed to limit the practice.
Ten years ago, the Credit CARD Act was passed, and limited the kind of fees creditors can charge. Now, borrowers must explicitly opt-in to have an account be able to go over the limit and incur over limit fees. And those fees are capped; one can only be charged the over limit fee two months in a row if it stays over the limit. The law states the first over-limit incident should incur a maximum fee of $25, and a second incident within six months would incur a $35 maximum fee.
But another provision of the law is that the over limit fee can’t be greater than the amount you’ve gone over. So it you go over your $5,000 limit to $5,010, you can only be charged a maximum of a $10 over limit fee.
Obviously, your best bet is to not opt in to over limit fees. Yes, your card may be declined if you reach your limit, causing embarrassment and inconvenience, but you’ll avoid a lot of extra fees. The CFPB’s (Consumer Financial Protection Bureau) “CARD Act Report” found that in the first 2 years it was in effect, the CARD Act saved borrowers 2.5 billion dollars in over limit fees.
Increasing Your Credit Limit
You can increase your overall credit limit by opening an additional account, but there are some drawbacks; you’ll be increasing your exposure to risk, taking a hit to your credit score (because of the new credit and the recent inquiry), and potentially looking riskier to lenders. On the other hand, a new account might have lower introductory rates, or offer you a good deal on a balance transfer.
Another way to increase your credit limit is simply to ask your current creditors. You can call and request an increased credit limit. If your payment history is good, your credit score is high, and your income is sufficient, it can be easy to get your creditor to increase your limit without the need to open a new account.
Be aware that this request will likely trigger a hard inquiry on your credit file, so look over your credit reports before you ask, so you can be sure everything there is accurate and up to date. If there is anything negative on your report that might lead the creditor to decline your request, spend some time addressing it before you approach them asking for a higher limit.
If you use your creditor’s web site to manage your account, you may be able to log in online and request a credit increase through the internet. If that option is not available, simply call their customer service number and explain that you’re interested in increasing your credit limit. Your creditor gets these calls all the time and will know exactly how to help you.
Review Your Credit
Before you ask for a credit limit increase, you need to make sure your credit information is accurate and reflects positively on you. If you don’t know where to start, a credit report review is available. Let a nonprofit credit coach help you improve your credit to get the best terms and the optimal credit limits on all of your accounts.
And if you’re thinking of raising your credit limit because you’ve maxed out your existing accounts, then we urge you to seek debt counseling first. Don’t address your debt problems by incurring more debt.