iQuanti: You've probably noticed on your credit card statement or online dashboard that you have a credit limit. What is a credit limit and what does it really mean?
Your credit limit is the total amount of money that the credit card issuer is essentially willing to lend you at any given time for purchases. For example, if your credit limit is $10,000, then you can spend up to $10,000 on goods and services. Anything above this limit will be automatically declined.
Your credit limit does not start over each billing cycle. It's a continuous balance that is only restored as payments are made. If you accumulate any interest or finance charges, these will also be subtracted from your available credit limit.
In this post, we'll explain how a card issuer decides your credit limit and some best practices for using it responsibly.
How is My Credit Limit Determined?
Your credit limit is based on a combination of several different factors:
- Credit history: Issuers will want to look at your payment history and the number of other credit lines you have open. Generally speaking, the better your FICO Score, the higher your limit will be.
- Financial situation: A lender will always want to know that you're financially able to pay your bills. Therefore, they'll ask questions about your gross income and any reoccurring debts you have such as your mortgage, student loans, auto loans, etc. This will be used to estimate your debt-to-income (DTI) ratio. Usually, a lower DTI means a higher limit.
- Employment history: The longer you've had a job, the higher your credit limit will be. This is because it's assumed you'll have better income stability.
- Derogatory marks: Your credit history may also have notes about bankruptcies, collections, civil judgments, or tax liens. These items could potentially lower your credit limit.
- The underwriting process: Each credit card company will have different rules about how they use the above information to calculate your credit limit.
Can My Credit Limit Be Raised?
Absolutely. Oftentimes, the credit card company will periodically raise your credit limit on its own. This is usually after several months or even years of demonstrating a reliable payment history.
You can always make a special request to the credit card company to increase your limit. This can be done online or by phone. Approval will typically have to go through a manual review, so it could take a few days before a decision is made.
If you do formally request a credit increase, the issuer will ask about your financial status again. They may even request proof of income (such as recent paycheck stubs or a W-2). This is so that they can validate that you're currently earning more money and can manage a higher limit.
Using Your Credit Limit Responsibly
Even though the card issuer will grant you a credit limit, using too much of it can hurt your FICO Score. For this reason, experts recommend that you should never use more than 30 percent of your available credit. For instance, if you have a credit card with a $10,000 limit, then the max you should ever use is $3,000.
One way around this rule is to simply have more than one credit card. For example, if you have two credit cards with a $10,000 limit each, then you could actually spend up to $6,000 between them. Credit score aside, it's always recommended that you should use your cards responsibly and never spend more than you can afford.
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Original Source: What Does Your Credit Limit Really Mean?
