What is a credit limit?
One of those things that can be a bit confusing is your credit limit. Even if you know the amount, you may not know how it is determined or how it affects other areas of your credit life, such as your credit score.
But you can relax because it’s not that complicated. I’ll tell you everything you need to know about your credit card credit limit.
Your credit limit is the maximum amount you can spend with your credit card. You won’t know what your credit limit will be until you are approved for the card you requested. An exception to this rule is applying for a secured credit card, where your security deposit often matches your credit limit.
And take note that your credit limit is not a suggestion, it’s a concrete number that you must stick to. You may be offered a chance to “sign up” and exceed your limit, but not without paying a fee. It’s like having overdraft protection for your credit card, but I urge you not to sign up for it. It’s a slippery slope for a lot of debt.
Next, let’s take a look at some of the more common areas that credit card issuers look at when deciding your credit limit amount.
To determine the amount of your credit limit, credit card companies look at a variety of factors to assess your creditworthiness. They take into account your income and the length of your employment. They examine your credit report in detail and, of course, examine your credit score. They all have their own criteria and they may even weigh the same factors differently.
Some issuers follow guidelines that have been established for a specific credit card. For example, the most basic unsecured credit card from a credit card company for someone with limited credit might have a preset credit limit of $ 700.
As already mentioned, with a secured credit card, your credit limit is usually the amount of your deposit. But in most cases, you can get your credit limit increased by increasing your security deposit.
Some of the more elite credit cards offer what’s called a “no-preset spending limit.” This means you don’t have a set limit, but it also doesn’t mean you can spend with abandon. It’s a kind of floating limit that changes with your spending habits, income, and other factors that affect your credit.
In this case, instead of telling you the maximum credit limit, some issuers will indicate what the minimum limit will be if you are approved for the card. So, for example, there might be a statement suggesting that if you are approved for the card, your minimum credit limit will be $ 5,000.
But whether you have a preset spending limit or a regular spending limit, your issuer will look at your financial information and look at the following four things: your credit report, your employment status, your debt-to-income ratio, and your credit rating.
Your credit report. This is a wealth of information for a lender. It can see your payment history and determine if you are paying your bills on time. It also examines your credit limits on other credit cards.
A lender also takes into account the length of your credit history and the number of recent serious inquiries. If you have a long credit history and pay your bills on time, you are likely to get a higher credit limit than someone with only a few years of history.
If your report shows a large number of recent inquiries, a lender may be wondering if you are having financial problems. Maybe you were just looking for signup bonuses, but that won’t say it on your credit report. It will appear that you are in desperate need of credit. If you still get approved for the card, it will affect your credit limit. And not in a good way, because you look risky.
The report also tells lenders if you have any past due accounts or recent bankruptcy. Even your demographic details that aren’t included in credit score calculations help tell your story.
Your employment status. Your income is one of the factors taken into account when issuers determine your credit limit.
When you apply for a credit card, your employment status is usually required on the application. This information may or may not show up on your credit report, depending on whether it was reported to the bureaus.
The credit score algorithm doesn’t take your income into account at all, so you can get a good score no matter how much you earn. But when a lender reviews your application, they like to see that you are employed with a decent income. Issuers want to make sure you can afford to make payments on your credit card balance.
Your debt-to-income ratio. You now know that your income is not a factor in your credit score. But this is where your income counts. A lender examines your DTI ratio to see if you have enough income to pay your credit card bill.
Your ratio is calculated using this formula: DTI = your recurring monthly debt / your gross monthly income (income before taxes).
Your debt includes things like your rent, mortgage payments, car payments, credit card payments, student loans, child support payments, and any other type of debt you pay off each month. Note that expenses such as utility bills, cell phone bills, and internet bills are not included in your DTI.
Have you ever heard of the “28/36 rule”? It is a gold standard used by many mortgage lenders. This means that you shouldn’t spend more than 28% of your gross income on housing. And your DTI, which includes all debt, must not exceed 36%.
We’re talking about credit cards, not mortgages, but it’s still a good guideline to follow. A credit card issuer will examine your DTI ratio to determine if you can financially manage a higher credit limit.
Your credit rating. Most issuers have a threshold for the credit rating they accept. But they also look at all of the other factors listed above. If you are near the threshold and have had a stable job, you may be considered for this.
I wouldn’t expect a high credit limit, however, if you barely made the cut. Issuers use the credit limit to help minimize their risk. So if they take your chance, they will offer you a low credit limit first to see if you can handle the credit. Do a good job of it, and over time you may be able to ask for a raise.
If you’re just starting your journey to great credit, your credit limit on your credit card may be lower than you want. And whether you get a “good” credit limit or not, it depends on your age, your credit history, and even the type of credit card.
An Experian survey in 2019 showed that the average credit limit increases with age. For example, with Gen Z (18 to 22), the average credit limit is $ 8,062.
In contrast, baby boomers (aged 55 to 73) have an average credit limit of $ 39,919. The longer your credit – if it is a very good credit history – the more likely you are to get a higher limit.
Sometimes the type of card is also a factor in the credit limit. Elite travel rewards cards target the big spenders, so they often have higher credit limits. Meanwhile, a simple card that you get when you’re starting out is unlikely to come with a high credit limit.
Try to resist the urge to compare your credit limit with friends who have the same card. You don’t know what’s in another person’s credit application or report.
The best way to be happy with your limit is to spend at least six months as a Star Cardholder. Once done, you can always request an increase in the limit. If you’ve managed credit well, you might get what you want.
If you use credit responsibly, you will see your credit limit and credit score increase over time. Just so you can see the whole picture, here’s a quick rundown of what goes into your FICO score:
- Payment history is 35% of your FICO score. You have an advantage if you have paid responsibly over a period of time.
- The length of your credit history is 15% of your score. Obviously, the longer you’ve had credit, the more it helps your score.
- The credit composition is 10% of your FICO score. As you get older, you will likely increase your credit. For example, in your twenties, you might have a car loan and credit cards. In your thirties, you might have a mortgage.
- New requests represent 10% of your credit score. If you apply for a credit card, a serious investigation will show up on your credit report. This can reduce your score by two to five points.
- The available credit is 30% of your score. Maintaining a low balance during the month can increase your score.
Since the available credit is 30% of your FICO score, having a low balance pays off. This is because you have what is called a credit utilization ratio. This is the amount of credit you have used versus the amount of credit you have.
For example, if you have a credit limit of $ 1,000 and you have a balance of $ 300, that’s a ratio of 30% (300/1000). It’s the maximum amount your ratio should ever be. But what if you want to boost your score? Use only 10%, which in this example is only $ 100 (100/1000).
A solid 30% of your FICO score is credit usage. So if you’ve only used 10% (or less) of your credit limit, your credit score may improve. Payment history makes up a whopping 35% of the FICO score, so you should also focus on paying all your bills on time.
If you strive to keep your credit usage low and pay all of your bills on time, your wallet and credit score will thank you. And once your score starts to rise, your creditworthiness and credit limit will start to rise as well.