How Credit Card Issuers Set Your Credit Limit – Forbes Advisor

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A credit limit describes the amount of money you can borrow from your credit card issuer at any given time. The average credit card limit on all accounts was $30,365 in 2020 according to Experian. No matter where your credit limits fall relative to the national average, it can be helpful to understand how credit issuers determine the maximum amount they’re comfortable lending you.

To manage risk, credit card companies take a lot of information into account when you apply for a new account. These details, such as your credit history, credit score, income, etc., determine in the first place whether you can open a new account. Beyond initial approval or denial, these same factors matter again when the card issuer sets the terms of your account, including your interest rate and credit limit.

Knowing the details that matter to credit card companies gives you an edge. You can work to become a low-risk borrower in the eyes of credit card issuers and lenders and position yourself for more attractive terms like lower interest rates and higher credit limits.

Read on for a closer look at five factors credit card companies can use to set your credit card limit.

Factor #1: Your credit information

Credit card issuers consider your credit information when setting your credit limit, and that’s probably no surprise. Your credit history and credit score can tell a lot about your debt management habits.

Credit history provides insight into how you’ve handled your credit obligations in the past, with credit card accounts and beyond. A credit score, however, is a predictive tool that lenders can use to assess risk. A FICO® score and a VantageScore credit score can tell a lender how likely you are to be 90 days past due (or worse) on any credit obligation within the next 24 months.

A good credit score that indicates a lower level of risk could help you qualify for a higher credit limit. Still, a bad credit score could narrow your credit card options, and you’re likely to receive lower credit limits on your accounts when you qualify.

Factor #2: Debt to income ratio (DTI)

The relationship between the income you earn and the debts you owe is another detail that can help determine the credit limit you receive. This figure is called your debt-to-income ratio, or DTI ratio. You can calculate it by dividing your monthly debt payments by your gross monthly income.

Your DTI ratio can help a credit card company determine your ability to take on more debt. If you already owe a large amount relative to your income, a large new line of credit could overwhelm you. But if you have a low DTI ratio, you are less likely to have a problem in this area.

Factor #3: Credit Utilization Ratio

Not only do creditors look at your overall DTI ratio, but a card issuer can also look at how you handle credit card accounts you have already opened. If you owe high outstanding balances relative to your credit card limits, your credit utilization rate is likely high and this status could cause you problems.

High credit usage doesn’t look good on new credit card applications. To make matters worse, it could also hurt your credit score, even if you make a habit of paying on time each month.

Finally, high credit utilization can often be costly. The average interest rate on a credit card (among those that charged interest) was 16.17% in February 2022 according to the Federal Reserve. But if you pay off your credit card balance each month (ideally before your statement closing date), you may be able to keep your credit utilization rate low and simultaneously avoid high interest charges.

Factor #4: Relationship with creditor

If you’ve dealt with a credit card issuer before — in the past or currently — the company will likely consider that relationship when deciding whether to approve you for a new account. If a card issuer approves you, they may also consider your past or current transactions when setting the credit limit on your new account.

Previous defaults or canceled debts in bankruptcy could be a deciding factor in credit card approval (at least for the same creditor). Of course, that doesn’t mean you can’t open a new credit card elsewhere, even after bankruptcy.

In a situation where you have existing credit cards with a credit card company, your existing credit limits could also affect you. A card issuer may prefer to extend a lower credit limit if you already have what they consider a high amount of available credit on other accounts they have. (Note: If this happens to you, you may consider asking the card issuer to “move” some of your credit limit from an old account to the new one.)

Factor #5: Details You Can’t Control

Some factors that influence your credit limit might have nothing to do with you. The economy and future economic forecasts, for example, might make a credit card company feel more or less comfortable extending credit. At the start of the pandemic, credit card issuers lowered credit limits for many customers. They took these steps in an effort to reduce their exposure to customers who could not afford to pay their bills as promised.

New or pending credit card legislation could also make a difference when it comes to credit limits. When the CARD ACT of 2009 was passed, some card issuers attempted to control their risk exposure by reducing lines of credit for customers who had too much unused credit.

How Your Credit Limit Can Affect Your Credit Score

The relationship between your credit limit and your credit card balance is called your credit utilization rate. This is a major factor in your credit score, with lower levels of credit utilization being best for you. A higher credit limit could help keep credit utilization low.

To calculate credit usage on an individual account, a credit scoring model takes into account two details of your credit report: the limit and the balance on your credit card. It’s your credit report numbers that matter here, not your real-time account balance. This is an important detail to note since credit card companies usually only update your account information once a month with credit reporting agencies (Equifax, TransUnion and Experian).

The more distance between your credit card balance and the limit, the better (this is where the benefits of a higher credit limit can come into play). A greater distance between these two figures should lead to a drop in the rate of credit utilization.

The Potential Credit Score Benefit of a Higher Credit Card Limit

Here is an example to help you understand how a higher credit limit can improve your credit score. Imagine that your credit report shows an account with the following data.

  • Credit card balance: $1,000
  • Credit card limit: $1,000

Your credit utilization rate would be 100% in the above scenario because you are using your entire available credit limit. A 100% used credit card could hurt your credit score.

Now, suppose the credit card account on your credit report is a little different.

  • Credit card balance: $1,000
  • Credit card limit: $10,000

In this second scenario, your credit utilization rate is only 10%. This figure should be much better for your credit score.

Of course, it’s important to point out that a higher credit limit can only benefit you if you manage your credit card responsibly. If you go overboard and keep charging for purchases until you max out your account, a higher credit limit will only increase credit card debt. As a general rule, you should aim to pay off your statement balance in full each month, regardless of how high your credit limit is.

Request a credit limit increase

If your account’s current credit limit isn’t as high as you’d like, there’s good news. Credit card issuers may increase your limit over time. It is also possible to proactively request a credit limit increase on your account.

Keep in mind that factors that may affect your initial credit limit allocation may also impact your ability to receive a credit limit increase. But if you’re working to pay off credit card debt or improve your credit score, such actions could improve the chances that your card issuer will approve your application.

It’s also important to let your credit card company know if your income increases, especially if you’re hoping for a higher credit limit. More income could lower your DTI ratio, provided you don’t take on new debt at the same time.

Conclusion

Credit card issuers base the credit limit they give you on a combination of factors, but primarily on how well you’ve managed your existing credit up to that point. Having a high credit limit can be a boon to your credit score, but only if used responsibly. Before you apply for a new card, be aware that you probably won’t be told in advance what your new account’s credit limit is, so choose a card based on your spending habits and particular needs, not on your own. a credit limit that you hope to receive.

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