The credit limit is an important component of any credit card, dictating the amount of money you are able to borrow. Credit limits vary greatly from person to person and largely depend on your credit score—the better your credit score, the higher limit you are likely to have.
Your credit limit isn't purely determined by your credit score though, many banks will award credit limit increases to customers who have a proven good payment history. In addition, as your credit profile improves you can apply for a credit card with a higher limit, but you should be aware that declined applications can damage your credit score and therefore potentially lower your limit.
Depending on your spending habits, a higher credit limit can be good or bad for numerous reasons. Here is an overview of some of the many advantages and disadvantages of raising your credit limit.
The advantages of raising your credit limit
A higher limit has several advantages, some of which are more obvious than others. A higher limit gives more flexibility to make larger purchases as well as have money available for emergency situations. A less obvious advantage is how much a higher credit limit benefits your credit score. Along those lines, a raise in your credit limit can give you good peace of mind in knowing that your financial situation is in good shape.
Having a card with a high limit can really help you get out of a jam when unexpected expenses pop-up.
More buying power
It's stating the obvious that with a higher limit comes the ability to use your credit card to make large purchases, for good or bad. Think of any time you want to buy a major appliance or a new gadget such as a computer. Many people don't want to spend all the cash they have on such a purchase. Store financing is an option, but that is another line on your credit report. With a higher limit credit card, you can make the purchase entirely on the card and not have to worry about getting new credit.
Money for a rainy day
Life is full of unexpected events. Car repairs, damage to your house, medical bills and much more can turn up in your life that you didn't plan for in your budget. Having a card with a high limit can really help you get out of a jam. If you need car repairs, a low limit card can't really help you. But if you have a high credit limit, you can get your car back and spread out your payments. Alternatively you could set up a savings account with easy access to your funds.
Increased credit score
A huge component of credit is your ratio of debt to credit. This means that if you owe $300 on a card with a $350 limit, you are taking a major hit on your credit rating even if you have perfect payment history. However, if you get an increase to $750, your debt to credit ratio lowers significantly, and that raises your score. An increased credit limit directly relates to an improved credit score.
Peace of mind
Another advantage is fairly simple. Getting a raise in your credit limit makes you feel good. It shows that you have followed through on your credit obligations and makes you more appealing to other lenders. It also lets you know that you are on the right track financially.
Changing your credit score can affect your credit score because it adjusts your debt to credit ratio. Find out more about this here.
The disadvantages of raising your credit limit
Of course, raising your credit limit has some potential disadvantages as money can't buy happiness. A higher credit limit obviously gives you the opportunity to increase your debt, but you also run the risk of paying more in interest too. Lastly, you can get a false sense of security in the knowledge that you have the added spending power that comes with a higher credit limit.
If you receive a credit limit increase, it also increases the chance that you won't be able to pay your bill in full.
This seems pretty obvious. If you have a higher credit limit, you have the opportunity to spend more money. That means that if you get a credit limit increase and max it out, your credit utilisation ratio will get worse, which can look bad in an application to new creditors. There's another problem: if you wanted to do a credit card balance transfer to a new credit card and you already have a substantial credit limit, you may not be given a high enough credit limit on the new card to transfer your whole balance.
Unless you pay your balance in full every month, you end up paying at least a small amount of interest. If you receive a credit limit increase, it also increases the chance that you won't be able to pay your bill in full. That translates to paying more interest to the issuing bank.
If your credit score is increasing, you will have more chances to obtain a new credit card or personal loan. This is especially true if you are rebuilding credit. Adding new credit has two drawbacks though. Firstly, a new credit line dings your score for a while. Secondly, it increases the chance that you will rely too heavily on your credit cards.
False sense of security
This disadvantage is especially true if you don't strictly monitor to your financial habits. If you receive a credit limit increase, it may convince you that your credit score has improved more than it actually has. That increases the likelihood that you will apply for new credit that adds inquiries to your credit report even if you don't get improved.
Raising your credit limit can be a great thing. If your credit card company offers you one, make sure you get all of the information from them. Make sure it is something you can handle financially. Remember, carrying credit card debt is never a good thing.
Treat your credit limit increase responsibly. It is very easy to ruin credit and takes time to build it back.
This post was originally published in February 2011 and has been updated for freshness, accuracy, and comprehensiveness.