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How does your credit score impact your credit limits?
In this article
When used responsibly, acan be a wonderful tool to help you access credit and improve your credit score. But what about your credit report and credit limits? Let’s take a look at how your affect your credit limits.
A credit limit is the maximum amount of money you can borrow at any given time. For example, let’s say you only have one credit source – a credit card with a limit of $5,000. In this example, your credit limit would be $5,000. If you had two cards with that limit, your combined credit limit would be $10,000 and so on. Your credit limit is the total of all your maximum credit limits across all product categories.
But, you won’t want to get this mixed up with your available credit. Your available credit is a running total of how much of your credit limit is currently available for borrowing. It sums up your total posted and pending transactions as of today’s date. Spending more than your available credit will likely lead to you getting an overage charge and impact your credit score.
When you apply for credit, a lender considers several factors to determine what your credit limit should be. Your debt, payment patterns, length of credit history, and rate of application for other forms of credit could all be considered and reviewed. Beyond these, your credit score is one of the most important factors in determining your credit limit. Because credit scores measure the level of risk associated with your profile, lenders rely on them heavily to determine how likely you are to pay your bills on time. If you have a strong credit score, lenders consider you to be a low-risk client and will reward you with high credit limits and low interest rates.
If you have a weak credit score, lenders will offer you a low credit limit with higher interest rates to assume less risk and deter you from missing payments.Another important factor is income. Since this is not considered in your credit score at all, lenders will ask to know your monthly or yearly earnings so they never offer you more debt than they think you can handle, even if you had a perfect credit score.Finally, lenders will likely pull your credit report for a detailed overview of your payment history and length of credit. This inquiry is considered a ‘hard pull’ of your credit report with your consent and will likely dock your score by a few points, since most credit score models consider how recently and frequently you apply for credit. If a lender approaches you with a credit product or limit increase, typically they’ve already done a ‘soft pull’ or inquiry of your credit report without your consent to see if you prequalify for any offers. A hard credit inquiry may impact your credit scores and stay on your credit reports for about two years, while a soft credit inquiry won’t affect your score.
Not all hope is lost if you have a low credit score. Sometimes, lenders like banks increase credit limits on accounts with a long history of good standing. So if you’re looking to increase your credit limit, open an introductory account or any line of credit with the limit you’re given and eventually your limit may grow as a reward for a solid history. This will also favour your credit score by incentivizing good payment habits.
The flip side of having a higher credit limit is that it comes with an opportunity to rack up more debt. That’s why it’s best to only rely on credit for costs that you are able to pay off in full. Try to limit making large purchases on your credit to prevent driving up your credit utilization rate past 30% and hurt your credit score. A low credit limit ideally won’t allow you to spend more than you can afford to pay but you’re still required to spend responsibly. To keep your credit score growing, keep your spending relatively low and manageable, always pay the entire balance of your credit bills by the payment due dates, and don’t skip or miss any payments.
If you max out your credit cards or have a high utilization rate, lenders may assume that you have a hard time paying off your credit card balance. That’s because every month, you seem to use most or all of your available credit, which suggests that you depend on borrowing money to make ends meet. A regular high ratio over 30% will likely lower your credit score and make lenders view you as a possible risk.
So to avoid falling into debt, remember to carry small balances that you can comfortably pay off each month. This will show lenders that you are a responsible borrower who can not only repay their balance on time, but resist spending their total available credit limit every month. Your credit score will thank you.
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Tassie heads up ClearScore Canada. She lives in Toronto with her husband and two young boys. In her free time, she can be found at the family lake house or playing ball hockey.