How changing your credit limit affects your credit score

• Thinking of requesting a higher or lower credit limit?
• Get the details on the role your credit limit plays in your credit score.

Your credit limit is not set in stone and the process of changing it is generally quite an easy one. However, being one of several factors in the algorithms used by credit bureaus to calculate your credit score, it is important to consider your options before submitting your application.

In this guide, we'll look at how your credit score responds to a change in credit limit, both increased and decreased.

What banks report to credit agencies

In order to calculate your credit score, banks report information about your credit limit to credit agencies. Data reported include everything from new credit applications, whether you were approved or not, repayments and their timeliness, etc. They also report information related to your credit limit, including:

• how much credit you applied for when you submitted your application to open an account;
• how much credit the bank extended to you to use (your credit limit);
• how much credit you are using.

These data are reported on a monthly schedule, giving the credit agency a snapshot in time of your finances.

Available credit and debt-to-credit ratio

Revolving credit products of all kinds — credit cards, store cards, and charge cards — have credit limits. Since the credit limit for each open revolving credit product is reported, the total amount of available credit can be calculated using simple addition.

Since the amount of credit used is also reported, it is therefore possible to calculate a debt-to-credit ratio by dividing the total amount of available credit by the total amount of credit used.

For example, if you have two credit cards, one with a credit limit of $10,000 and another with a credit limit of $8,000, your total available credit is $18,000. If the balance owing on card A is $6,000 and on card B is $1,200, your total debt is $7,200. Your debt-to-credit ratio is calculated as a percentage, i.e. 7200 / 18000 x 100 = 40%.

A large amount of available credit is not necessarily going to damage your credit score by itself, but someone using a high percentage of their available credit may be viewed with more caution than someone using a small percentage. The effect of a high debt-to-credit ratio combined with missed payments may be of particular concern to a bank for obvious reasons.

Therefore, careful consideration should be given to the impact of changing your credit limit on your debt-to-credit ratio.

Raising your credit limit may involve a new credit check

If you have done the numbers and still want to change your credit limit, there is something else to consider: it may involve the bank running a credit check as part of their decisioning process.

This matters if you are planning to apply for a new credit card, finance, lease, personal or home loan because:

• banks may consider several applications for credit within a short period of time as a sign of underlying financial problems, even though your credit score may not be affected or temporarily drop by a few points;
• banks may be less reluctant to approve a customer's application when another bank has recently rejected an application.

A bank performing a credit check has a small, short-term effect on your credit score, but as we will go on to discuss, a rejected application is more problematic.

A higher credit limit may help improve your credit score

In the long term, a higher credit limit may actually help to improve your credit score. However, there is one important caveat: your debt-to-credit ratio.

If you get a higher credit limit and your balance stays the same, then your debt-to-credit ratio will be lower, which is likely to improve your credit score over time. Paying down your debt will reduce the debt to credit ratio further and your credit score should improve thereafter.

However, if you cannot control your spending, your debt-to-credit ratio will be higher and your credit score may drop as a result.

Is your credit score affected if your application is rejected?

It depends. If you have applied to raise your credit limit, your bank may or may not perform a credit check. If they do and then reject your application, this will most likely temporarily reduce your credit score.

Bear in mind that the decision may be recorded on your credit report, which other banks can see when performing a credit check. Keep this in mind if you are planning to apply for a new credit product in the near future since it may make it more difficult.

If your application to raise your credit limit was refused

While it may be disheartening, it is not the end of the road. There are things you can do before trying again.

1. Make sure you don't miss your monthly repayment.
2. Reduce new spending so your debt does not keep growing.
3. Make repayment amounts greater than the monthly minimum repayments, to reduce your debt-to-credit ratio.

These apply to any open revolving credit account you may have in your name. If the bank run a credit check, they will see your overall debt-to-credit ratio, so simply diverting spend to one of your other accounts will not change the amount of available credit you have used.

Reducing your credit limit may increase your debt to credit ratio

Knowing that your debt to credit ratio is an important factor in the calculation of your credit score, it makes sense to consider what it may be in future should you decide to reduce your credit limit.

If it works out that reducing your credit limit will increase your debt-to-credit ratio substantially — and you have the funds available — then it may be a good idea to make a one-off payment before reducing your credit limit. You can calculate your current debt to credit ratio easily and since you know how much additional credit you are applying for, you can calculate what it would be — if approved — and therefore what to pay down to keep a low debt to credit ratio.

Final thoughts

Ultimately you are the one responsible for your finances and how you manage your spending and payments will determine your credit score. Changing your credit limit may change your debt-to-credit ratio, and that is what you should be aware of before applying.