What Is a Credit Limit?
A credit limit is the maximum amount of money that a credit card issuer or lender will extend to a borrower for a line of credit. Credit limits can be set for either secured or unsecured lines of credit. A secured line of credit means that the borrower has offered up some form of asset or collateral in the event that the account is delinquent for an extended period of time. One example of a secured line of credit is a business loan, which can be secured in a variety of ways including with real estate. The credit limit then fluctuates based on the equity in the real estate.
An unsecured line of credit, on the other hand, does not involve any form of collateral. Instead, the maximum amount of credit that a lender will offer you is calculated based on the borrower’s creditworthiness.
According to Experian, the average credit limit in the U.S. in 2020 was $30,365.
Why Does It Matter?
First of all, your credit limit is the maximum amount of money that you can borrow from a lender. Credit card companies and lenders set these numbers strategically based on the information in your credit report. They want to be sure that they do not lend you more money than you can realistically pay back.
It’s important to know how much money, both your own and borrowed, that you have at your disposal so that you can effectively and efficiently adjust your budget and set goals.
Further, credit limits matter because they indirectly impact your credit score. A credit limit lays the groundwork for your credit utilization, which, for the most well known credit scoring models, accounts for one third of your total score. If you don’t mind your limit, you will see a significant drop in your credit score, which could affect whether or not you get approved for loans and other lines of credit in the future.
Who Sets Your Limit?
When you apply for a credit card or other line of credit, the lender performs an inquiry into your credit report. Based on the information in your credit report, they first determine whether you are worthy of receiving credit at all. Then they set your credit limit based on how you’ve handled credit and debt in the past.
How Is Your Credit Limit Calculated?
A lender will determine your credit limit by looking at several different pieces of information in your credit report.
- Payment history: Do you pay your credit card bills and loans on time? Have you ever had an account sent to collections or filed for bankruptcy?
- Current accounts: What credit card accounts and loans do you currently have open? What are the credit limits on those accounts?
- Credit history length: How long have you had your current accounts? Have you applied for any new accounts recently?
- Debt: How much credit are you using? How much money do you owe to your lenders?
- Income: How much money do you make? Is it enough to cover a monthly bill?
Certain factors may be weighed more heavily depending on which credit card company you have applied with. However, in general, the better your payment history has been, the better shape that your current accounts are in, the less debt you have, and the higher that your income is, the more money your lender will let you borrow.
What Happens if You Go Over the Limit?
If using your credit card for a transaction would cause you to exceed your maximum credit limit, a couple of things could happen. First, the transaction may simply be denied. This means that you would have to provide another valid form of payment in order to complete the transaction.
Some credit card companies or lenders will charge you a fee if you are opted into over-the-limit coverage programs. These programs operate much the same as overdraft protection. If you make a purchase but it exceeds your limit, the credit card issuer can spot you, but they’ll charge you a fee for doing it.
These programs are optional. In other words, you will not automatically be opted into the program when you apply for the credit card or line of credit. You must explicitly opt in in order for the lender to cover a transaction. Remember: You can opt into and out of these programs at any time.
If you do opt in and get hit with an over-the-limit fee, don’t be afraid to negotiate it. Not every negotiation will end in success, but it’s worth the effort. Worst case scenario: The customer service representative says no. Best case scenario: You get some money refunded.
Credit Limit vs. Available Credit
Your credit limit is the total amount of money that your credit card company or lender is willing to extend to you. Available credit, on the other hand, is how much credit you have at your disposal at any given time while taking into account how much credit you have already used.
For instance, say your credit card company issues you a credit card with a $1,000 limit. Your current credit card balance balance is $280.
$1,000 – $280 = $720
That would make your credit limit $1,000, while your available credit is $720.
How Does Credit Limit Affect Credit Scores?
Your credit limits play a significant role in your credit score. When credit scoring agencies calculate your scores, they consider several different factors, including: payment history, credit utilization, length of credit history, credit mix, and new credit.
Credit limits directly relate to credit utilization, which accounts for about one third of your credit score. Credit utilization is the total percentage of your credit limit that is in use at any given time.
Once again, let’s say that you have a credit card with a credit limit of $1,000, and you’ve used $200 worth of that credit.
$200 ÷ $1,000 = .20 or 20%
That means that your credit utilization, or credit utilization ratio, is 20%. You’ve used 20% of your total credit limit.
How to Change Your Credit Limit
A credit limit is automatically generated when you apply for a credit card or another line of credit. However, after some time you can ask for a higher credit limit, or your credit card company can raise or lower your limit for any number of reasons.
A credit card issuer can increase your credit limit if you:
- Have used your credit wisely in the past
- Consistently make on-time payments
- Update your account to show an increase in income
- Increase your credit score
- Request a credit limit increase
A credit card issuer can decrease your credit limit if you:
- Have missed payments
- Rarely use your card, or have quit using it altogether
- Have taken on more debt
- Have a negative mark on your credit report
- Are dealing with identity theft or fraud