What Is a Credit Limit?
Your credit limit is one of those things that can be a little confusing. Even if you know the amount,  Your credit limit is one of those things that can be a little confusing. Even if you know the amount, you might not be aware of how its determined or how it impacts other areas of your credit life, such as your credit score. But you can relax because its not that complicated. Im going to tell you everything you need to know about your credit cards credit limit. Heres what well cover:   Credit limit definition.  How your credit limit is determined.  How your credit limit impacts your credit score. Credit Limit Definition  Your credit limit is the maximum amount that you can spend with your credit card. You wont know what your credit limit will be until youre approved for the card youve applied for. An exception to this 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  its a concrete number that you have to respect. You may be offered a chance to opt in and exceed your limit but not without paying a fee. This is like having overdraft protection for your credit card, but I urge you not to opt in. Its a slippery slope to a lot of debt. Next, lets take a look at some of the most common areas that credit card issuers review when they decide the amount of your credit limit. [Read: Best Cash Back Credit Cards.] How Your Credit Limit Is Determined  To determine the amount of your credit limit, credit card companies look at a variety of factors to gauge your creditworthiness. They consider your income and how long youve been employed. They review your credit report in detail and, of course, look at your credit score. They all have their own criteria, and they might even weigh the same factors differently. Some issuers follow guidelines that have been set for a specific credit card. For example, a credit card companys most basic unsecured credit card for someone with limited credit might have a preset $700 credit limit. As already mentioned, with a secured credit card, your credit limit is usually your deposit amount. But in most cases, you can get a credit limit increase by increasing your security deposit. Some of the more elite credit cards offer whats called a no preset spending limit. This means you arent given a definite limit, but it doesnt mean you can spend with abandon, either. Its kind of a floating limit that changes with your spending habits, income and other factors that impact your credit. In this case, instead of telling you the maximum credit limit, some issuers state what the minimum limit will be if you are approved for the card. So, for instance, there might be a statement suggesting that if youre 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 review your financial information and look at the following four things: your credit report, your employment status, your debt-to-income ratio and your credit score. [Read: Best Credit Cards with High Credit Limits.] Your credit report. This is a gold mine of information for a lender. It can see your payment history and determine if you pay your bills on time. It also looks at your credit limits on other credit cards. A lender also considers the length of your credit history and the number of recent hard inquiries. If you have a long credit history and pay your bills on time, then youll probably get a higher credit limit than someone who only has a few years worth of history. If your report shows a lot of recent inquiries, a lender might wonder if youre having financial trouble. Maybe you were just chasing sign-up bonuses, but it wont say that on your credit report. It will look like you desperately need credit. If you still get approved for the card, this will impact your credit limit. And not in a good way, because you look risky. The report also tells lenders if you have delinquent accounts or a recent bankruptcy. Even your demographic details that arent included in credit score calculations help tell your story. Your employment status. Your income is one of the factors considered when issuers determine your credit limit. When you apply for a credit card, your employment status is usually required on the application. That information may or may not show up on your credit report, depending on whether it was reported to the bureaus. The credit score algorithm doesnt consider your income at all, so you can attain a good score no matter how much or how little you make. But when a lender looks at your application, it likes to see that youre employed with a decent income. Issuers want to make sure that you have the means 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 heres where your income does matter. A lender looks at your DTI ratio to see whether 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 payment, car payments, credit card payments, student loans, alimony payments and any other type of debt you pay each month. Note that expenses such as utility, cellphone and internet service bills are not included in your DTI. This is a gold standard used by many mortgage lenders. It means you should not be spending more than 28% of your gross income on housing. And your DTI, which includes all debt, should not exceed 36%. [Read: Best Travel Rewards Credit Cards.] Were talking about credit cards, not mortgages, but its still a good guideline to follow. A credit card issuer will consider your DTI ratio to determine if you can financially handle a larger credit limit. Your credit score. Most issuers have a cutoff for the credit score theyll accept. But they also look at all the other factors listed above. If youre close to the cutoff and youve had stable employment, you might get consideration for that. I wouldnt expect a high credit limit, though, if you barely make the cut. Issuers use the credit limit to help minimize their risk. So, if they take a chance on you, theyll offer a low credit limit at first to see if you can handle credit. Do a good job with it, and, in time, you can ask for an increase. If youre just starting out on your journey toward great credit, your credit limit on your credit card might be lower than what you wanted. And whether you get a good credit limit or not depends on your age, credit history and even on the type of credit card. A 2019 survey from Experian showed that the average credit limit increases with age. For instance, with Generation Z (ages 18 to 22), the average credit limit is $8,062. In contrast, Baby Boomers (ages 55 to 73) have an average credit limit of $39,919. The longer you have credit  if its 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 big spenders, so they often have higher credit limits. Meanwhile, a plain vanilla card that you get when youre starting out probably wont come with a high credit limit. Try to resist the urge to compare your credit limit with friends who have the same card. You dont know whats in another persons application or credit report. The best way to be satisfied with your limit is to spend at least six months being a stellar cardholder. Once you do that, you can always ask for a limit increase. If youve done a good job handling credit, you might just get what you want. How Your Credit Limit Impacts Your Credit Score  If you use credit responsibly, youll see your credit limit and your credit score increase over time. Just so you can see the whole picture, heres a brief rundown on what goes into your FICO score:   Payment history is 35% of your FICO score. You have an advantage if youve paid responsibly over a period of time.  Length of credit history makes up 15% of your score. Clearly, the longer youve had credit, the more it helps your score.  Credit mix is 10% of your FICO score. As you get older, youre likely to increase your credit mix. For example, in your 20s, you might have a car loan and credit cards. In your 30s, you might have a mortgage.  New inquiries are 10% of your credit score. If you apply for a credit card, a hard inquiry will show up on your credit report. This can knock anywhere from two to five points off your score.  Available credit is 30% of your score. Maintaining a low balance during the month can boost your score. Since available credit is 30% of your FICO score, it pays to have a low balance. Thats because you have whats called a credit utilization ratio. This is the amount of credit youve used compared with the amount of credit you have available. For instance, if you have a $1,000 credit limit and you have a $300 balance, thats a 30% ratio (300/1,000). Thats the maximum amount your ratio should ever be. Use only 10%, which, in this example, is only $100 (100/1,000). A solid 30% of your FICO score is credit utilization. So, if youve used only 10% (or less) of your credit limit, your credit score can improve. Payment history is a whopping 35% of the FICO score, so you also want to focus on paying all of your bills on time. If you are diligent about keeping a low credit utilization ratio and paying all of your bills on time, both your wallet and your credit score will thank you. And once your score starts going up, your creditworthiness and your credit limit will also start to rise. originally appeared on usnews.com  Update 07/07/21: