Credit limit: does it make sense to use it to the maximum?

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Image source: PTI The credit limit is the maximum amount you can spend with a credit card.

The first thing banks or financial institutions say about a credit card is your credit limit. Even when we plan to request one, we buy it based on its limit. The terms credit limit or credit card limit are therefore not foreign to most credit card users.

As a reminder, the credit limit is the maximum amount that can be spent with a credit card. Usually set by issuing banks / financial institutions, the credit limit is not the same for every credit card. Just like the way credit cards come in different shapes and sizes (features and benefits), so too does the credit limit.

Before you even know how much of your card’s credit limit can be used, let’s take a look at some of the basics of credit limit.

How do banks decide on the credit limit?

The exact method of calculating the credit limit is not known as it is specific to the bank. As a result, it often becomes difficult to predict your credit limit. However, there are a few known things that banks usually take into account when determining your credit limit. Your monthly income, fixed expenses and financial obligations.

Banks examine various documents such as payslips, tax documents, bank statements, and credit report to get a clear picture of your financial situation.

Once they have everything in hand, they usually multiply the gross monthly income by 2-3 times, deduct all monthly obligations including basic monthly expenses, fixed monthly obligations such as IMEs for loans, the if applicable, to determine the credit limit. The multiplier may vary depending on the risk factor of the applicant and the bank’s credit policy.

In addition, the applicant’s debt ratio, which is calculated by dividing all IMEs by the monthly salary, will also be taken into account when determining the credit limit.

The cash limit is part of the credit limit

While the credit limit indicates the maximum spending limit on the card, the cash limit tells you how much money you can withdraw with your credit card.

Credit cards offer a cash withdrawal feature that allows the user to withdraw a certain amount of money.

One thing to consider here is that the cash limit is part of the total credit limit and should not be viewed as an additional amount available on the card.

For example, if your credit card limit is Rs 50,000 and the cash limit is Rs 10,000, the total limit available on the card is still Rs 50,000 and not Rs 60,000. Simple, the cash withdrawal limit is part of the credit limit, not an addition to it.

The consequences of using your maximum credit limit

Now back to the main point, what credit limit can be used. This may seem invalid to many, as the limit itself sets a cap on credit card use and limiting it again makes no sense. However, experts still recommend that you don’t use your credit limit to the max. They say that using the credit limit completely results in a high credit usage rate which hurts your credit score. Let’s see how it goes.

Credit rating and credit utilization rate

You may be familiar with the term “credit score,” which is a number calculated from your credit history and repayment behavior. A higher score usually indicates that your credit risk is lower, making lenders approve your loans quickly and easily.

Well, speaking of credit utilization rates, few are aware of this and its impact on their credit score. Simply put, the credit utilization rate is the percentage of credit used over the total credit limit. The total credit limit includes the credit limit on all existing credit cards held by an individual.

For example, if you have three credit cards of different origin, each with a credit limit of Rs 10,000, and you have spent Rs 2,000 on each card, your credit usage rate will be calculated by taking the sum of spending on all cards. , divided by the credit limit of all cards. Here it is 8,000 / 3,000 * 100, which gives you a credit utilization rate of 26.67%.

Using the maximum credit limit results in a higher credit utilization rate

The credit utilization rate basically shows how much credit you have used against the total credit limit. While a low utilization rate indicates that you are less dependent on credit, a higher rate indicates that you are heavily dependent on it.

Your credit utilization rate will not be higher until you use your credit limit to its fullest. For example, imagine you have three credit cards with a credit limit of Rs 10,000 each, you spent Rs 9,000 on each card, then your credit utilization rate becomes 27,000 / 30,000 * 100, that which equals 90%. This means that you have used 90% of your total credit limit.

The credit utilization rate can be calculated for a single card or for multiple cards. When you only consider one card, the higher credit utilization rate is the result of your maximum credit limit. The closer you get to your credit limit, the higher your credit utilization rate will be.

High credit utilization rate = low credit rating

The very first consequence of a high credit utilization rate is a low credit score. The reason – the credit utilization rate is an important factor taken into account in determining a person’s creditworthiness and it has an impact on 30% of the credit score.

A low credit score, as mentioned earlier, indicates higher credit risk and affects your eligibility for a loan. Citing it as the reason, banks may penalize you for a lower loan amount or high interest rate loans, or sometimes reject your application if your score is too low. Whatever the consequence, having a low credit score is not healthy if you plan to take out large loans in the future, such as a home loan.

What credit limit can be used?

Now that you are aware of the consequences of using your maximum credit limit, let’s take a look at how much you can use to be more secure.

Experts recommend maintaining a 30% credit utilization rate, which means you should limit your credit card spending to 30% of the total credit limit. Whether you use a single card or multiple cards, make sure that your total spending does not exceed 30% of the total limit.

If you have a total credit limit of Rs.1 lakh, to get a good credit score you should limit your credit card spending to Rs.30,000 to Rs.35,000. Also make sure you pay dues. unpaid on time.

If you find it a little difficult to reduce your spending, a pro tip would be to increase your credit limit. Improving the credit limit, however, is only possible if you’ve used the card for at least six months and have a decent repayment history.

You can request a credit limit increase by contacting your bank’s customer support lines. The approval of the request is entirely at the discretion of the bank.

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