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A credit limit is the maximum amount you can charge to a revolving account, such as a credit card or a line of credit. Lenders look at your credit to determine your limit—and your limit may change over time depending on how you manage your account. Read on to find out more about how credit limits work.
How Does a Lender Determine Credit Limit?
When you apply for a new credit card or line of credit, the lender assesses your creditworthiness to decide on the maximum amount it's willing to lend to you. To determine your creditworthiness, the lender typically looks at one or more of your credit reports or credit scores provided by the three consumer credit bureaus (Experian, TransUnion and Equifax). The lender may also take into account other factors, such as your reported household income and your payment history with that particular lender.
How Does Credit Limit Impact Creditworthiness?
The amount of money you owe is a key factor in determining your creditworthiness. But rather than looking at the absolute amount you owe, lenders consider the ratio of how much you owe on all of your accounts combined compared with the total amount of credit you've been extended in revolving loans, such as credit cards (in other words, your total credit limits). This is called your credit utilization ratio, sometimes referred to as debt-to-credit ratio, and it's calculated by dividing all of what you owe on your revolving accounts by your total credit limits.
When you have a high utilization rate, lenders consider it a sign that you may be experiencing financial difficulty—a strong indicator of lending risk. A high utilization ratio hurts your credit scores, which may dissuade lenders from extending you additional credit. A rate of 30% or higher will negatively affect your credit scores—but for the best scores, you need to keep your utilization under 10%.
One way to control your utilization ratio—and to help your finances overall—is to carry little or no revolving debt. You can also ask your lenders to raise your existing credit limits, which they may consider if you have a record of keeping your balances low and paying your bills on time every month.
Conversely, if you close an existing line of credit, your total credit limit decreases, which can hurt your credit utilization. This is why it's a good idea not to close infrequently used credit card accounts; instead, put the cards in a drawer or place them where you won't be tempted to use them.
What Is the Difference Between Credit Limit and Available Credit?
While your credit limit is the total amount of money that's available for you to borrow, your available credit is just the unused portion of your credit limit. For example, if you have a total credit limit of $2,000 across all of your revolving accounts, and the total of all of your balances is $500, then you have $1,500 in available credit remaining. For more information, see "How Much Available Credit Should I Have?"
Why Did My Credit Limit Change?
Occasionally, a card issuer or lender might notify you that your credit limit has changed, either because it's been increased or decreased. A credit limit increase is a sign that the lender feels your creditworthiness has improved and may be due to many possible factors. You might receive an increase because you use your credit cards and other revolving credit responsibly by paying your bills on time and carrying little, if any, debt. Another factor can be time passing since negative information, such as late payments, first appeared on your credit report. Also, if you've reported increased income, the lender may consider this another reason to offer you a higher credit limit.
Lenders can also lower your credit limit. Your credit card issuer or other lenders might have noticed a decrease in your creditworthiness due to factors such as late payments or higher credit utilization. However, it's also possible that a card issuer could lower a customer's credit limit due to low utilization.
While you might be tempted to look at your credit limits as a judgment of your personal finances, these numbers simply represent the most that a lender was willing to offer you at a particular time. By understanding how credit limits work, and how they can affect your credit scores, you can take the steps necessary to keep your credit on track.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.
This article was originally published on January 3, 2017, and has been updated.