Your credit limit is the available spending power that you have on a given credit account. Think of it as an “allowance” that your bank gives you to spend on the card. The difference between this and the allowance you may have got from your parents when you were younger is that you have to pay this back, plus some. Bummer, right? So is having a higher credit limit good or bad? In general, it’s a good thing and can benefit your credit. But, like all things in life, there are also drawbacks for every positive.
Benefits of Having a Higher Credit Limit
There are many benefits to credit limit increases, and having a higher credit limit in general. But you’ll need to have self control – without it, these positives can turn into negatives very quickly.
Lower Credit Utilization – One of the biggest advantages that a high credit limit gives you is a lower credit utilization, assuming your spending stays constant. This makes up 30% of how your credit score is calculated, according to the FICO model, making it the second most important factor behind payment history.
More Spending Power – More available credit obviously gives you the opportunity to buy more stuff! (Danger zone) While you have to be careful here, this can provide a little bit of financial flexibility that can come in handy if something unexpected comes up.
Good Standing with Your Bank – If you see a credit limit increase without even asking, or if you’ve requested and received it, it typically indicates that you’re on good terms with your bank or credit union.
The Downside of Having a Lot of Available Credit
Maybe you’ve heard people refer to their credit as “fake money”. Well… it’s not. Sorry to be the bearer of bad news. Once reality hits, you could find yourself in trouble if you’ve spent beyond your means.
Spending Temptation – Having a higher credit limit gives you the opportunity to buy more, or more expensive items. Be careful of getting in the habit of thinking “I’ll worry about paying it later”. Because “later” will come sooner than you think. Be sure to manage your spending wisely and avoid spending more than what you can afford to pay back.
Hard Inquiries from Credit Limit Increases – Hard and soft credit inquiries will affect you differently. If the provider reviews your credit and decides to give you an increase, it’ll likely be a soft inquiry, which won’t impact your credit score. However, if you’ve requested a credit limit increase, chances are it will result in a hard inquiry, which will affect your credit score.
Determine Your Credit Limit Before Applying
Especially if you’re applying for your first credit card at a bank, credit union, or store, you may want to figure out how to know your credit card limit before applying. Unfortunately, it’s not that simple. There’s no single way to accurately calculate what your credit limit will be, mainly because the methods behind determining credit limits varies from provider to provider.
Although the formulas differ, credit limits are usually determined by considering the applicant’s credit history, income, employment history, and DTI (debt to income ratio). Some companies will also weigh in other factors like marital or residential status. There are companies that use different tiers or credit card levels that consumers can apply for. For instance, let’s say your credit union has three credit cards to offer: silver, gold, and platinum. The respective credit limits may be $1000, $5000, $7000. So consumers would qualify for one (or none) of those three cards, based on what range they fall into when the creditor reviews their application.
The best way to go is to communicate with your bank or credit union that you’re considering applying with to discuss what your credit limit would likely be. You’ll want to do this before you apply, otherwise you’ll end up with a potentially damaging hard inquiry on your credit report. Especially if this occurs multiple times, you could hurt your chances of being approved for a credit card overall, and cause your credit score to drop.
Should I Cancel a Credit Card with a Low Limit?
You should not cancel a credit account simply because you’re not happy with the credit limit. This could potentially be damaging to your credit because you’ll be erasing all positive payment history and reducing the age of your credit – two things that directly affect your credit score. The best way to go in this case is to keep the account open, and your credit utilization low. Credit bureaus will look at credit utilization on a per-account basis, as well as overall or the aggregate utilization.