Find out how Consolidated Credit can help you!

Home » How to Use a Credit Card the Right Way » Credit Limits

Credit Limits

Your credit limit: is it a financial asset or a potential pitfall? Credit limits are a fundamental aspect of modern finance, but they’re often misunderstood. Many view it as simply a spending cap, but it’s far more than that. When managed strategically, your credit limit can be a powerful tool for boosting your cash flow and achieving your financial goals. However, misuse can lead to debt and damaged credit.

We’ll guide you through understanding credit limits, maximizing their benefits, and, most importantly, avoiding the common traps that lead to financial strain. We’ll explore how credit limits are determined, how to use them responsibly, and how to turn them into a key element of your financial success.

Understanding your credit limit

Credit cards are a type of revolving credit, meaning they extend to you a line of credit that has a specific limit which renews every month. Every financial institution has rules for how these limits are determined, so it’s essential to understand your credit card terms and conditions to know how they will affect your budget and spending.

What is a credit limit?

A credit limit is the maximum amount of money your credit card company allows you to borrow. It’s the highest amount you can charge on your card. Banks use credit limits to manage risk, allowing you to make purchases while controlling the amount of debt you can accumulate. This limit is part of a “revolving credit” system, meaning it resets each month as you pay down your balance, making the credit available again.

Credit limit vs. available credit

It’s important to understand the difference between your credit limit and your available credit. Your credit limit is the total amount you are approved to borrow. Available credit is the amount you currently have left to spend. For example, if your credit limit is $5,000 and you’ve spent $2,000, your available credit is $3,000. Your credit limit is generally fixed, while your available credit changes as you use your card.

Maxing out your credit card

“Maxing out” means you’ve reached your credit limit, charging the maximum amount your credit card company allows. This has several negative consequences:

Limited Spending: You can’t make any more purchases on that card until you pay down your balance.
Credit Score Impact: It significantly increases your credit utilization ratio (the percentage of your available credit you’re using), which can hurt your credit score. Lenders see maxing out a card as a sign of potential financial trouble.
Potential Fees: Some credit card companies may charge over-limit fees if you exceed your credit limit.
Financial Red Flag: Reaching your credit limit signals to lenders that you may be having financial difficulties.

What affects my credit limit?

There are a variety of factors that go into determining your limit. Lenders use a mix of credit history, income, debt-to-income ratio, and co-applicant qualifications to determine how much credit to extend to you. The type of card may also affect the limit.

Credit history

Your past relationship with credit has a big effect on your limit. This is largely reflected in your credit score, a three-digit number that summarizes your creditworthiness. Credit scores are calculated based on your borrowing and repayment history, with higher scores indicating lower risk to lenders. If you are new to credit or have a history of missed payments or high debt, you can expect a low credit score and, consequently, a low credit limit to start. For example, a history filled with late payments and high balances significantly lowers your credit score, making lenders hesitant to extend a high credit limit. On the other hand, a long credit history with consistent on-time payments, a good credit score (typically 700 or above), and positive financial relationships with lenders usually result in higher credit limits.

Income

In most cases, a higher income means a higher credit limit. However, this is not a guarantee and limits can still vary based on other factors.

Debt-to-Income Ratio

Using the information on your credit card application, lenders will determine your debt-to-income ratio (DTI) and use it to judge your credit limit. Your DTI is the percentage of your gross monthly income that goes towards paying off your debts. Lenders use this ratio to determine your ability to manage additional debt. Lenders generally prefer a DTI of 36% or lower. A DTI above 43% may make it difficult to qualify for a loan or credit card. If you have high monthly debt payments compared to your income, it’s likely that your lender will set a lower credit limit for you, or deny the application entirely.

To calculate your DTI, simply divide your total monthly debt payments by your gross monthly income (your income before taxes and deductions). Then, multiply the result by 100 to express it as a percentage.

Type of card

Various types of cards have different rules for limits. Companies like Chase, Discover, Citi, and more will all determine their own credit limits for the cards they offer.

Co-applicant qualifications

If you are applying for a credit card with someone else, that applicant’s information will also be used when determining your limit. This can be good or bad, depending on the co-applicant.

How to use Credit Cards Articles

What doesn’t affect my credit limit?

While many factors influence your financial life, some don’t directly impact your credit limit. Here’s what lenders typically don’t consider:

Your bank account balance

The amount of money in your checking or savings accounts doesn’t directly determine your credit limit. Lenders are more interested in your ability to consistently repay debt, as reflected in your credit history and DTI. While a healthy bank balance is beneficial, it doesn’t necessarily indicate responsible credit management.

Other assets and overall net worth

The value of your assets, such as investments or property, and your overall net worth generally don’t directly influence your credit limit. Lenders are more concerned with your monthly cash flow, than your overall wealth.

Prepaid expenses

Paying for expenses in advance, such as a year of insurance, will not affect your credit limit.

Cash based spending

Spending habits that do not involve credit, such as cash purchases, will not affect your credit limit.

Using credit limits to your advantage without creating challenges with debt

Using your credit limit wisely isn’t about spending more; it’s about strategic borrowing. To build good credit and earn rewards without debt, understand your credit utilization—how much of your limit you use—and only borrow what you can comfortably repay each month. Remember, carrying a balance means paying interest, which can outweigh any rewards.

The 30% utilization rule and its significance

Though you can max out your credit card, it’s best to keep your balance below 30% of your limit. For instance, on a $10,000 limit, aim for under $3,000. Why? Because credit utilization heavily influences your credit score. Going over 30% signals risk to lenders, potentially impacting your loan approvals and interest rates.

Practical tips for keeping utilization low

So, how do you actually keep your credit utilization low? Let’s dive into some easy-to-follow tips:

Multiple payments throughout the month: Make several payments throughout the billing cycle, rather than one large payment at the end, to keep your balance low.
Automatic payments: Set up automatic payments for at least the minimum amount due to avoid late payments, which can also affect your credit utilization.
Regular spending monitoring: Keep track of your spending and credit card balances to stay within your desired utilization range.
Responsible credit limit Increase requests: If you consistently maintain low utilization, consider requesting a credit limit increase. This can lower your utilization ratio without changing your spending habits. However, only do this if you are sure you will not increase your spending.
Strategic use of multiple cards: If you have multiple credit cards, distribute your spending across them to keep the balance on each card low.

Benefits of a high credit limit when used responsibly

A higher credit limit, when managed responsibly, can offer several advantages:

Emergency financial buffer: A higher limit can serve as a financial safety net in times of need.

Lower utilization ratio: With a higher limit, your spending will represent a smaller percentage of your available credit, which positively impacts your credit score.

Increased financial flexibility: A higher limit provides more flexibility for unexpected expenses or larger purchases.

Improved credit score over time: Consistent responsible use of a higher credit limit, with low utilization and on-time payments, can contribute to a stronger credit score.

Can I change my credit limit?

You can’t change your limit yourself, but you can request credit limit increases from your lenders. Financial institutions make this pretty easy. You can ask them to raise your limit online or call your credit card issuer’s customer service department. After you complete your request, they will notify you if you are approved or denied for a higher limit. Getting denied for a higher limit will not hurt your credit score, and neither will requesting one.

How can I increase my chance of approval?

Lenders favor applicants who demonstrate financial stability and responsible credit management. To improve your chances, focus on: a proven track record of on-time payments, consistently low credit utilization, a strong income-to-debt balance (lower DTI), a healthy credit score, and demonstrating loyalty through a long-term customer relationship.

Avoiding debt and overspending

While a high credit limit offers advantages, it’s important to be aware of the potential drawbacks. Raising your limit can result in overspending or even credit card debt. You can easily run into fees, penalty rates, and other negative consequences. Spending too much on a credit card can drain your budget, leave you juggling bills, and hurt your credit score. A high credit utilization ratio or a large amount of debt will have a big effect on your credit report and can drop your score significantly. This could make it harder to buy a home, get a car, or receive a personal loan.

So, the bottom line is this: Take your credit very seriously, especially if you already have high debt. After all, it’s a limit, not a goal.

If high credit limits have you stuck with debt, talk to a certified credit counselor to find the best way to pay off your balances.

Free Evaluation

FAQs

How much of my credit limit can I use?

Although we don’t recommend it, you can use all of your limit. If you spend over your limit, though, you may be subject to fees and penalties. Why don’t we recommend using all of the credit extended to you? Because using too much of it can negatively affect your credit score by raising your minimum payment. Your total current balance divided by your total available credit limit reflects your credit utilization ratio on your credit report. Any ratio above 30% hurts your credit score. The higher your credit card balance, the higher your utilization ratio.

Can my credit limit be lowered without my consent?

Yes, credit card issuers can lower your credit limit if they perceive an increased risk, such as a drop in your credit score, changes in your spending habits, or due to economic downturns.

What happens to my credit limit if I close a credit card account?

Closing a credit card account reduces your total available credit, which can increase your credit utilization ratio and negatively impact your credit score. So think carefully before closing credit card accounts.

If I’m an authorized user on someone else’s credit card, does their credit limit affect my credit score?

Yes, if the card is reported to credit bureaus, the credit limit and utilization of the primary cardholder can impact your credit score as an authorized user.

What are no preset spending limit cards?

Credit cards with no preset spending limit don’t actually mean that you can charge however much you want. Companies set soft limits based on your spending habits and other factors.