Definition of credit limit
What is a credit limit?
The term credit limit refers to the maximum amount of credit that a financial institution gives to a customer. A lending institution extends a credit limit on a credit card or line of credit. Lenders usually set credit limits based on the information provided by the credit applicant. A credit limit is a factor that affects the credit scores of consumers and can affect their ability to obtain credit in the future.
Key points to remember
- The term credit limit refers to the maximum amount of credit that a financial institution gives a customer on a credit card or line of credit.
- Lenders usually set credit limits based on the consumer’s credit report.
- A lender typically gives high-risk borrowers lower credit limits because they lack capital and the ability to repay debt. Low risk debtors are usually given higher credit limits, which gives them more flexibility when spending.
6 benefits of increasing your credit limit
Understanding credit limits
Credit limits are the maximum amount a lender will allow a consumer to spend using a credit card or revolving line of credit. The limits are determined by banks, alternative lenders, and credit card companies and are based on several pieces of information relating to the borrower. These lenders look at the borrower’s credit rating, personal income, loan repayment history, and other factors.
Limits can be set for unsecured credit and secured credit. Unsecured credit with limits often comes in the form of unsecured credit cards and lines of credit. If the line of credit is secured, backed by collateral, the lender considers the value of the collateral. For example, if someone takes out a home equity line of credit, the credit limit varies based on the equity in the borrower’s home.
Lenders will not issue a high credit limit for someone who will not be able to repay it. If a consumer has a high credit limit, it means that a creditor views the borrower as a low risk borrower. This borrower has a greater ability to spend with a higher credit limit.
High credit limits can be troublesome when they allow overspending and the borrower cannot meet their monthly payments.
A credit limit works the same whether the borrower has a credit card or a line of credit. A borrower can spend up to the credit limit, but if it exceeds that amount, they can face fines or penalties in addition to their regular payment. If the borrower spends less than the limit, they can continue to use the card or line of credit until they reach the limit.
Credit limit vs available credit
A credit limit and available credit are not the same. If a borrower has a credit card with a credit limit of $ 1,000 and the cardholder spends $ 600, they have an additional $ 400 to spend. If the borrower makes a payment of $ 40 and incurs finance charges of $ 6, their balance drops to $ 566 and they now have $ 434 of available credit.
Can lenders change credit limits?
In most cases, lenders reserve the right to change credit limits. If a borrower pays their bills on time every month and doesn’t go over their credit card or line of credit, a lender can increase their line of credit. This has a number of benefits, including increasing the borrower’s overall credit rating and accessing more and cheaper credit.
On the other hand, if the borrower does not repay or if there are other signs of risk, the lender may choose to reduce the credit limit. A reduction in the borrower’s credit limit increases the balance / limit ratio. If the borrower uses a large portion of his credit, it becomes a higher risk for current and future lenders.
Credit limits and credit scores
A person’s credit report shows the credit vehicles they use as well as each account’s credit limit, high balances, and current balances. High credit limits and multiple lines of credit hurt a person’s overall credit rating.
Potential new lenders can see that the applicant has access to a large amount of open credit. This is a red flag for a lender simply because the borrower may choose to maximize their lines of credit and credit cards, extend their debts too much, and become unable to repay them. Since high credit limits have this potential effect on credit scores, some borrowers sometimes ask creditors to lower their credit limits.
Derek Notman, CFP®, ChFC, CLU
Intrepid Wealth Partners, LLC, Madison, WI
When applying for credit, consider the following checklist to be the best prepared:
- Make sure the lender knows why you need the money. Why are you asking for credit? Having a clear reason will make them more comfortable.
- Have a personal financial statement already completed. The bank will ask you, so be prepared.
- Have your income tax returns for the past two or three years, the bank will ask you for them as well.
- Be prepared to use one of your assets as collateral to secure some or all of the credit. It can be real estate, life insurance with cash value, or a business asset. Don’t give it away right away, but use it as a bargaining chip.
- Don’t be afraid to try to negotiate the interest rate on the credit.
- Being prepared will show a lender that you are organized, serious, and hopefully make them feel like a low risk borrower.
What is a credit limit?
A credit limit is the amount of unsecured or secured credit that a lender will extend to a borrower through a revolving loan vehicle such as a credit card, personal line of credit, or home equity line of credit. Lenders grant credit limits based on several factors, including the borrower’s credit rating, other types of credit they have, income, and on-time payment history.
What is the available credit?
Available credit is simply the unused portion of a borrower’s credit limit at any given time. So if someone has a total credit limit of $ 10,000 on their credit card or personal line of credit and have already used $ 5,000, they will have the remaining $ 5,000 as available credit to which they could access. Available credit may fluctuate throughout the billing cycle based on account usage. The opposite of available credit is the credit utilization level – which tracks the percentage of the line of credit that is in use at any given time.
What is a credit score?
A credit score is a calculated value that serves as an indicator of a borrower’s creditworthiness or ability and the likelihood that they will repay their debts on time in accordance with the terms of the loan agreement. Credit scores are generated by credit reporting agencies such as Experian, Equifax or TransUnion and use formulas that assign weights and values to factors such as payment history, amounts owed, duration credit history and use of credit. Credit scores are not the same as credit reports, the latter are simply records of the types and status of credit accounts that are reported to credit bureaus by lenders.