What is a credit limit?
A credit limit is the maximum amount of money a lender or financial institution will allow you to borrow on a credit account. Learn more on credit limits here.
Ever wonder how credit limits are set? Let’s get a better understanding of what credit limits are, how they are determined, and tips on how to increase your credit limit.
A credit limit is the maximum amount of money a lender or financial institution will let a customer access through a credit account on a credit card, line of credit, loan, or mortgage.
To determine your credit limit, a lender will look at various factors including credit history, income, employment status, and overall financial situation. They assess these factors to determine a borrower’s ability to repay the debt and then assign an appropriate credit limit. People with stronger credit histories and stable incomes are more likely to be granted higher credit limits.
For lenders, credit limits help control their losses in the event that a borrower defaults on a payment.
What are the different types of credit?
There are two types of credit: revolving credit and installment credit.
Revolving credit allows you to borrow up to your maximum credit limit, pay it back over time, and use the credit available again. Credit cards and lines of credit are two common types of revolving credit.
Installment credit like mortgages and car loans provide you with a lump sum of money, which you must repay in fixed installments by a certain date.
While revolving credit allows you to pay back your credit over time, installment credit is available for a predetermined time known as a loan term. With an installment loan agreement, you will receive all the money upfront as well as an amortization schedule for repayment installments to pay down the principal including a fixed or variable amount of interest gradually over the specified loan term.
In summary, here are the main differences between a revolving credit and installment credit.
- Credit limit can be used at any time and borrowed again as needed
- Often has higher interest rates
- Borrowers only pay interest on the amount they use
- Borrowers only pay interest on the amount they use
- Can be tougher to qualify for
- Fixed number of payments, including interest, over a set period of time
How are credit limits determined and initially assigned?
Lenders and credit card companies use a process called underwriting to determine your credit limit.
Underwriting uses mathematical formulas to determine your credit quality and your ability to repay. Each company has its own way to determine who is approved, at what rate and with what credit limit. When a lender offers you a higher credit limit, they assume more risk. So, people with higher credit scores and incomes and who can prove financial stability, tend to be offered higher credit limits than less secure borrowers.
What factors affect your credit limit?
What factors are lenders using to determine your credit limit?
Most companies check your credit report and gross annual income to determine the amount they will lend to you. Your employment history and stability as well as your debt to income (DTI) ratio is also be considered.
When reviewing your credit report lenders are reviewing factors such as your repayment history, the length of your credit history, and the number of credit accounts on your report.
Here are a few items that underwriters review on your credit report before assigning a credit limit:
- Credit score
- Student loans
- Auto loans
- Personal loans
- Credit cards
- Number of inquiries for new loans
- Civil judgements
- Tax liens
Your relationship with the lender may have an impact on what credit limit they will give you. The relationship may allow for more risk tolerance from an financial institution but will generally not inform the amount of credit or credit limit due to fair credit rules.
What are the factors that cause credit limit changes?
Your credit limit can be changed up on your request or if your lender notices change in your current situation, they can make a change to your credit limit too.
Here are some factors that might cause your credit limit to change.
- Credit score – If your credit score improves, a lender might increase your credit limit. Conversely, your credit limit could decrease if your credit score lowers.
- Income change – An increase to your income might prompt a lender to increase your credit limit as it suggests a greater ability to handle debt.
- Payment history – Consistency with on-time payments might lead to a credit limit increase from lenders, while missed payments might result in a decrease to your credit limit.
- Credit utilization – Maintaining a low utilization ratio (credit used vs. credit available) can be rewarded with a higher credit limit.
- Request for increase – If your financial situation has changed, you might be able to ask for an increase to your credit limit.
- Account age – Older accounts with good payment history might be eligible for credit limit increase.
- Changes in your credit report – Any changes to your credit report such as new accounts and delinquencies, could trigger a change to your credit limit.
Available credit vs credit limit vs credit utilization: What’s the difference?
When using credit in your financial situation it is important to understand how much is available to you, what your credit limit is, and how to manage that debt. Knowing this information is crucial in your steps to organize your finances responsibly.
Here are a few important terms to remember when it comes to managing your credit:
- Available credit – is the amount you of credit you have access to before you reach your credit limit.
- Credit limit – is the maximum amount of funds you can access with the credit you have been given by the lender
- Credit utilization – generally expressed as a percentage, this number is equal to the amount of revolving credit you’re using divided by the total credit limit available to you. This ratio is used to help lenders determine how you’re managing your current debt.
How to manage your credit score and avoid exceeding your credit limit
If your balance is over the limit when it’s reported to the credit bureaus, your credit score might drop. Credit utilization (how much of your available credit you use) accounts for 20% of your credit score. It is recommended by the Consumer Financial Protection Bureau to keep your credit utilization under 30%. For example, if you have $1000 credit limit, it is recommended to keep your credit utilization below $300.
6 tips for increasing your credit limit
While the following tips can help increase the chances of your credit limit being increased, remember that there are no guarantees. Each lender has their own policies and criteria for assigning credit limits. Credit is a tool you can use to help achieve your financial goals.
Here are a few ways that might help you increase your credit limit:
1. Build a strong credit score
Do all the things you need to maintain a good credit history to build up your credit. Also, ensure you don’t apply for too many credit cards and lines of credit as it also impacts your credit score.
2. Maintain a good credit history
Make sure you pay your bills on time and avoid late payments or going into default with your accounts. Remember to keep your credit utilization below 30% of your available credit. Having a good credit score history proves to lenders that you are responsible about your credit management.
3. Demonstrate responsible credit usage
Use your credit cards responsibly by keeping your balances low and pay them off monthly. Avoid increasing your credit card utilization ratio by carrying large balances and maxing out your card.
4. Review your credit report regularly
Consistently check that your credit report is up to date and accurate. Ensure that there are no errors or discrepancies such as incorrect balances or accounts that don’t belong to you. If you do see these problems, report them to your credit bureau.
5. Communicate with your lender
Some lenders might automatically review your account annually to provide changes to your credit limit. But it does not hurt to reach out and ask for the possibility of a credit limit increase. Prepare to give reasoning as to why you might deserve a credit limit increase, including improved credit history or increased income.
6. Increase your income or reduce your debt
If you’re income has been increased through a raise or a new position, it might be a great time to reach out to your credit lender about the possibility of an increased credit limit. Additionally, reducing your debt can also favorably impact your debt-to-income ratio and allow for increased credit limits.
Having a better understanding of your credit limit will empower you to manage your credit responsibly. When you access credit consider how that might impact your overall credit score. Check out the score simulator in BMO CreditView to better understand the impact of some activities on your credit score. By doing this you are making your credit work for you, rather than against you.
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