What is a credit limit and does it matter?
If you apply for or use a credit card, you may be wondering how much you are able to spend when using that card. This is called a credit limit. We take a look at what a credit limit is and what it means.
Definition of credit limit: what is it and where is the term used?
A “credit limit” is the maximum amount that a lender will lend to you through one of its credit products. The term is widely used in the financial products market and can apply to all types of loans, such as home, auto, personal or margin loans and credit cards.
What is a credit limit on credit cards?
When you take out a credit card, you are taking out a loan from a financial institution. You also agree to repay this loan under certain conditions. Usually, credit cards are set up so that you continually borrow a portion of the loaned amount and repay it on a schedule, and you are charged interest based on that repayment schedule.
The credit limit is the amount of credit (money lent) that you and the lender have agreed to use on this card. But it is important to know that this does not automatically mean that the card will stop working when its credit limit is reached. It depends on the loan agreement you have with the financial institution. (Read more about that, below.)
How does a credit card credit limit work?
A financial institution may offer credit card products with different credit limits, such as a $10,000, $20,000, or $50,000 credit limit. Let’s say someone chose a card with a credit limit of $10,000. This means that the total amount of money a person can borrow with this credit card would be $10,000 in total. That person would apply for the credit card, and the financial institution would assess their application and decide whether or not to issue the card and credit limit to the applicant, taking into account factors such as their credit rating. If the application was successful, that person would receive the credit card (or a virtual version of it) and could use it to borrow up to $10,000 for purchases.
A hypothetical example to explain how this might work is below:
Joe is approved for a credit card with a credit limit of $10,000. He can track his spending on this card through his bank’s mobile app. He will use the card to purchase items for his home office renovation.
Before Joe starts using the credit card, he checks his banking app. The credit card balance summary on its app shows:
- Balance: $0
- Available: $10,000
On Monday, he buys a computer worth $3,000 using the card. The credit card balance summary on its app shows:
- Balance: – $3,000
- Available: $7,000
On Tuesday, he buys a $1,000 desk and a $4,000 couch. Balance summary:
- Balance: -$8,000
- Available: $2,000
On Wednesday, he pays $2,000 to his credit card because he knows he needs extra funds on the card to buy more items. Balance summary:
- Balance: – $6,000
- Available: $4,000
On Thursday, he buys a podcast production system worth $4,000. Balance summary:
- Balance: – $10,000
- Available: $0
Fees and charges would also apply, depending on the terms and conditions of the credit card, and would gradually be reflected in the statement.
With $0 available on his credit card, whether or not Joe could continue making other transactions — and go over his credit limit — would depend on the particular policy he took out with a lender and the terms. general rules that apply to his credit agreement. .
Can you go over your credit card credit limit?
Whether or not you can spend more than your credit limit on your credit card depends on the credit agreement you have with your financial institution. It’s a good idea to find out what the financial institution’s rules are regarding “over-limit” spending before you sign up for a credit card.
Some agreements automatically prevent transactions from being completed once the credit limit is reached. In this case, purchases may be declined once a user has spent up to the authorized limit. Some financial institutions allow credit card holders to request that they not be allowed to exceed their credit limit, to help them control their level of debt. Other financial institutions will only allow certain eligible cardholders to exceed their limit, such as those with strong credit histories.
If you spend over your credit card credit limit, you may be charged additional fees or interest, but it depends on the policy you have with a financial institution. Not all banks charge an “over limit” fee (also known as an over limit fee). However, any purchase made using a credit card is added to the card balance, which means you still have to pay it back within a certain time frame, usually with interest. Even if you don’t plan to spend more than your credit card limit, fees and charges could cause your account to be overdrawn. Your personal credit rating can be negatively affected if you don’t make regular payments to your credit card.
Credit limits: why are they important?
Credit limits on credit cards are important for several reasons, including:
1. Determine how much you can spend
Since the credit limit on a credit card is the maximum amount you can borrow on that card, credit limits determine how much money you will have available for purchases. Compared to other types of loans, credit cards are generally more flexible in terms of when you can spend the funds and what you can spend them on. For example, credit cards usually allow you to borrow a succession of small or larger sums and use them to buy whatever you need (as long as the seller accepts the type of credit card you have) . Whereas if you take out a car loan, for example, you must use the loan for a car. Keep in mind, however, that money borrowed from a credit card must be repaid under strict terms and generally attracts a higher rate of interest on outstanding balances than some other forms of credit.
2. Consider how much you owe
The credit limit is the amount of money you can borrow from the financial institution. If you have a high credit limit, you can borrow up to that amount and repay it in installments, with interest if certain conditions are not met. If you want to try to minimize your level of debt, having a high credit limit could be an unwelcome temptation to spend more and therefore increase your level of debt. However, if you opt for a lower credit limit, it can help you control your spending. Keep in mind that fees and charges, including interest, generally apply when using a credit card, and they can add up over time. Developing a budget and learning how to manage expenses effectively can be helpful in minimizing overall debt, and you might even consider saving and creating an emergency fund, instead of relying on credit.
3. Can impact your credit rating
The amount you have borrowed – or asked to borrow – will be shown on your credit report, which financial institutions and other parties can verify. This includes credit card information and the total credit limits of those cards. The total credit limit, regardless of how much credit you have used, will be taken into account when calculating your credit score. For example, you might have multiple credit cards from different banks. Your debt level will be calculated by adding the credit limits of all your credit cards. Your repayment history is also taken into account. Why is this important? Banks will check your credit score every time you apply to borrow money, and your credit score may affect other applications, such as rental properties. You can check your credit score for free with Canstar.
If you are considering a credit card, it is important to read the policy documents, such as Target Market Determination and Key Information Sheet that apply, to support your decision making.
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