Your credit limit is one of those things that can be a little confusing. Even if you know the amount, you might not be aware of how it’s determined or how it impacts other areas of your credit life, such as your credit score.
But you can relax because it’s not that complicated. I’m going to tell you everything you need to know about your credit card’s credit limit.
Credit Limit Definition
Your credit limit is the maximum amount that you can spend with your credit card. You won’t know what your credit limit will be until you’re approved for the card you’ve applied for. An exception to this is applying for a secured credit card, where your security deposit often matches your credit limit.
And take note that your credit limit is not a suggestion — it’s a concrete number that you have to respect. You may be offered a chance to opt in and exceed your limit but not without paying a fee. This is like having overdraft protection for your credit card, but I urge you not to opt in. It’s a slippery slope to a lot of debt.
Next, let’s take a look at some of the most common areas that credit card issuers review when they decide the amount of your credit limit.
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How Your Credit Limit Is Determined
To determine the amount of your credit limit, credit card companies look at a variety of factors to gauge your creditworthiness. They all have their own criteria, and they might even weigh the same factors differently. In general, your issuer will review your financial information and look at the following four things: your credit report, your employment status, your debt-to-income ratio and your credit score.
[Read: Best Credit Cards with High Credit Limits.]
Your Credit Report
This is a gold mine of information for a lender. It can see your payment history and determine if you pay your bills on time. It also looks at your credit limits on other credit cards.
A lender also considers the length of your credit history and the number of recent hard inquiries. If you have a long credit history and pay your bills on time, then you’ll probably get a higher credit limit than someone who only has a few years’ worth of history.
If your report shows a lot of recent inquiries, a lender might wonder if you’re having financial trouble. Maybe you were just chasing sign-up bonuses, but it won’t say that on your credit report. It will look like you desperately need credit. If you still get approved for the card, this could impact your credit limit.
The report also tells lenders if you have delinquent accounts or a recent bankruptcy. Even your demographic details that aren’t included in credit score calculations help tell your story.
Your Employment Status
When you apply for a credit card, your employment status is usually required on the application. That information may show up on your credit report, depending on whether it was reported to the bureaus.
The credit score algorithm doesn’t consider your income at all, so you can attain a good score no matter how much or how little you make. But when a lender looks at your application, it likes to see that you’re employed with a decent income to make sure you have the means to make payments on your credit card balance.
Your Debt-to-Income Ratio
A lender looks at your DTI ratio to see whether you have enough income to pay your credit card bill. Your ratio is calculated using this formula: DTI = your recurring monthly debt / your gross monthly income (income before taxes).
Your debt includes things such as your rent, mortgage payment, car payments, credit card payments, student loan payments, alimony payments and any other type of debt you pay each month. Note that expenses such as utility, cellphone and internet service bills are not included in your DTI.
Ever heard of the “28/36 Rule”? This is a gold standard used by many mortgage lenders. It means you should not be spending more than 28% of your gross income on housing. And your DTI, which includes all debt, should not exceed 36%.
[Read: Best Travel Rewards Credit Cards.]
We’re talking about credit cards, not mortgages, but it’s still a good guideline to follow. A credit card issuer will consider your DTI ratio to determine if you can financially handle a larger credit limit.
Your Credit Score
Most issuers have a cutoff for the credit score they’ll accept. But they also look at all the other factors listed above. If you’re close to the cutoff and you’ve had stable employment, you might get consideration for that.
I wouldn’t expect a high credit limit, though, if you barely make the cut. Issuers use the credit limit to help minimize their risk. But if you use your credit cards responsibly over time, your score will improve and you can request a credit limit increase.
What Is a Good Credit Limit?
If you’re just starting out on your journey toward great credit, your credit limit on your credit card might be lower than what you wanted. And whether you get a “good” credit limit depends on on many factors, including your credit history and even the type of card you get.
For instance, elite travel rewards cards target big spenders, so they often have higher credit limits. In contrast, a plain vanilla card that you get when you’re starting out probably won’t come with a high credit limit.
The best way to be satisfied with your limit is to spend at least six months being a stellar cardholder. Once you do that, you can always ask for a limit increase. If you’ve done a good job handling credit, you might just get what you want.
How Your Credit Limit Impacts Your Credit Score
If you use credit responsibly, you’ll see your credit limit and your credit score increase over time. Just so you can see the whole picture, here’s a brief rundown on what goes into your FICO score:
— Payment history is 35% of your FICO score. You have an advantage if you’ve paid responsibly over a period of time.
— Available credit is 30% of your score. Maintaining a low balance during the month can boost your score.
— Length of credit history makes up 15% of your score. Clearly, the longer you’ve had credit, the more it helps your score.
— New inquiries are 10% of your credit score. If you apply for a credit card, a hard inquiry will show up on your credit report. This could knock anywhere from zero to five points off your score.
— Credit mix is 10% of your FICO score. The more types of credit you can handle, such as revolving credit and installment loans, the higher you’ll score in this category.
Since available credit is 30% of your FICO score, it pays to have a low balance. That’s because you have what’s called a credit utilization ratio. This is the amount of credit you’ve used compared with the amount of credit you have available.
If your credit utilization ratio exceeds 30%, it can decrease your score. So if you keep it under 30%, your score can improve. But here’s a tip: To boost your score the most, keep your ratio under 10%.
If you are diligent about keeping a low credit utilization ratio and paying all of your bills on time, both your wallet and your credit score will thank you. And once your score starts going up, your creditworthiness and your credit limit will also start to rise.
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What Is a Credit Limit? originally appeared on usnews.com
Update 02/01/23:
