Credit cards are one of the most popular forms of payment today. Chances are that you have at least one card in your wallet right now. While you’re probably familiar with how credit cards work, many aspects often baffle people.
For example, how do financial institutions determine what limit to set on your credit card? Why does your limit sometimes increase automatically? Can it go down?
Anytime you’re dealing with money and loans, it’s important to understand exactly how they function. This guide will explain what you need to know about credit card limits.
What is a Credit Card Limit?
The limit assigned to your credit card is the maximum amount you’re able to charge to your card. For example, if your credit card limit is $2,500, you cannot make purchases that exceed this amount.
If you have several credit cards in your wallet, it’s likely that each card has a different limit. So, how do credit card issuers determine how much credit to extend to you?
How is Your Credit Card Limit Determined?
Each creditor has their own set of rules and policies for setting credit limits. For example, one lender might place a greater weight on your annual income, while another focuses more on your credit score. There will be slight discrepancies between issuers; however, they all focus on key figures.
Your credit report and score provide lenders with a glimpse into how well you manage credit and loans. Your score is determined through five main components:
- Payment History (35%): How often you make payments on time.
- Amount Owed (30%): How much debt you currently have outstanding.
- Length of History (15%): How long you have been using credit cards and loans.
- Credit Mix (10%): How much of your debt is secured versus unsecured.
- New Credit (10%): How often you are applying for new credit cards or loans.
Each of these figures will play a role in how your credit card limit is determined. To illustrate how each section can impact your credit limit, review the following examples:
- Payment History: If you’re frequently late making payments, lenders might view you as a higher risk and restrict how much credit they extend to you.
- Amount Owed: Creditors will likely be more reluctant to give you a higher limit if you already have a significant amount of credit card debt.
- Length of History: If you’re just beginning to build credit, issuers will generally give you a lower credit limit until they can see how you manage the card.
- Credit Mix: If you only have secured loans (ex: auto loan or mortgage), creditors might offer a lower limit initially to determine how well you handle the credit card.
- New Credit: If lenders see you applying for multiple credit cards in a short period, they will often assume you’re in financial trouble and refrain from issuing credit or offer a much lower limit.
- Your Gross Annual Income
Another figure that will determine your credit limit is how much income you earn annually. Lenders don’t want to extend a substantial amount of credit to someone if they know they cannot repay it. Nor do they want to put a person in a situation where they’re tempted to spend more than they can reasonably manage.
Many people assume that your income appears on your credit report, but this is false. Nowhere in your credit report is your income stated. When applying for a credit card, the lender will request this information.
There are two main types of credit cards: secured and unsecured. The most popular form is an unsecured credit card where no collateral is necessary. You most likely have an unsecured card in your wallet right now. The limits on these cards are determined through the above methods.
A secured credit card is different in that it requires collateral. This card type is often used by people just learning to manage credit or those looking to rebuild damaged credit scores. For example, a borrower will give the lender $500 in exchange for a $500 secured credit card. The card functions just like a normal credit card. However, if the individual cannot make the monthly payments, the lender will use the $500 deposit to cover the charges.
Because unsecured credit cards are typically tied to a credit-builder program, the limits are often set at $250, $500, or $1,000.
Can I Increase My Credit Limit?
Yes, it’s quite common for your credit limit to increase. Many credit card issuers will automatically increase your credit limit if they notice you managing your card responsibly. However, the most popular way to bump up your limit is by asking.
- Requesting a Credit Limit Increase:
Some issuers will allow you to request a limit increase through your account online. For others, you simply need to give them a call. Once you request a limit increase, the creditor will determine if you qualify. This decision is entirely up to the lender; however, areas that can help increase your odds of approval include:
- Credit Score Increase: If your score has increased since you initially received your credit card, that will demonstrate to the lender you can responsibly manage your debts.
- Income Change: A jump in your annual income will often encourage creditors to extend you more credit. Married couples that combine their finances after marriage frequently see a boost in their credit limit since they have two incomes now.
- Card-Type Transition: If you have successfully shown you can manage a secured credit card and are ready for an unsecured card, issuers will generally extend you a higher limit than the lower credit-building thresholds of unsecured cards.
Can My Credit Limit Decrease?
Yes. While a decrease in your credit limit typically doesn’t happen often, it can occur. The most common reasons for this situation are:
- Card Inactivity: If you rarely use your credit card, your lender might reduce your credit limit or close the account entirely.
- Irresponsible Use: If you’re regularly maxing out your credit card or failing to make timely payments, your creditor could reduce your limit or close your account.
- Economic Reasons: If the economy is in a downward trend, lenders tend to tighten up and restrict the amount of funds they make available for consumers to borrow.
Credit card companies must typically provide 45 days’ notice if they plan to reduce your credit limit. If your limit is going to be decreased, use that time to pay off any funds over your new limit or transfer the funds to a new credit card.
We’re Here to Help!
While credit cards are one of the most convenient forms of payment, they are still loans. And the more you know about how they work, the better position you’ll be in to use them responsibly and to your advantage.
If you have questions about your credit card or would like to transfer high-interest balances to a credit union card, we’re ready to help. Please give us a call to get started today.