When you apply for your first credit card, one thing you are most excited about is that it gives you access to a good amount of funds which you can use to shop, buy things which you cannot purchase otherwise, and break your big expenses in small amount EMIs. So, credit cards are an efficient tool to handle everyday expenses and big-ticket purchase and make your life easy to track the same whenever you need to.
Understanding the fundamental aspect of utilizing a credit card involves grasping the concept of a credit limit. The credit limit signifies the highest amount of credit that a card issuer grants to a cardholder. Essentially, it denotes the maximum sum that one can utilize with a credit card. It serves as a restriction on spending, preventing individuals from exceeding the predetermined capacity assigned to their card.
How is the Credit Limit Decided?
Your credit limit is decided based on your income, repayments and payment history in the past. There are multiple factors based on considerations below:
Credit Score and Income
Your credit score plays a key role in helping you get the credit limit. It is one of the most important factors to help you get a higher limit. The higher the credit score, the more will be the permissible credit limit – since that would generally increase the creditworthiness of the person concerned. Your credit history is what is one of the most important factors for lenders and your past credit exposure, such as credit cards, loans taken, and past payment behaviour are factors that will reflect your ability to repay your debts on time.
Additionally, your income is another important criterion. The higher the income level, the larger the credit limit that will be allowed to you, as it would prove the ability to repay the amount you have spent on your credit cards before the due date.
Debt-to-Income Ratio
The debt-to-income ratio measures your monthly debt expenses in relation to your gross monthly income. In simple terms, it represents the percentage of your income that is allocated to repaying debts each month. The DTI ratio compares your debt payments with your gross monthly income, acting as an assessment of your ability to manage debt repayment.
Employment and Income
A stable employment and income are necessary to help you become eligible for products like credit cards. The higher the income and the longer the employment, the chances of you getting a credit product are higher. Long-term and stable employment can help enormously in influencing your credit limit since it sounds off financial stability to the lender. If your income is high, the credit card issuer is likely to offer you a higher credit limit and keep offering a hike based on your usages.
Credit Utilisation Rate (CUR)
The CUR represents the percentage of available credit that a borrower is currently using. It is calculated by dividing the total amount of credit currently being used by the total amount of credit available. This is the rate you are using and is the percentage of your credit limit that you actually use. A low ratio of utilisation, usually below 30% considered good, is helpful to your credit score. High credit utilisation may affect your credit score, and therefore future borrowing.
How Does Credit Limit Change Over Time?
You must remember that the credit limit offered to you at the time of approval of your card is not fixed. It keeps changing based on your repayment history and credit behaviour. The issuing bank can lower your credit limit and increase it based on how you manage your card. Let’s look at some reasons that can lead to decrease in your credit limits:
Regular Reviews by Issuers
Card issuers generally do regular reviews of your account and may adjust your credit limit. Changes in the limit can be made according to your credit behaviour and financial position.
Credit Limit Increases
Responsible credit behaviour, including on-time payments and low credit utilisation, will automatically promote, or collate at request, a rise in the credit limit. Banks will send you offers through mails and phone calls and ask you to go for a higher credit card limit. Based on your usages, you may opt for a higher credit limit or keep it unchanged.
Credit Limit Decreases
Conversely, actions such as missed payments, a high utilisation rate, or declining financial situations may trigger a reduction in the credit limit. The deterioration in credit profile can lead to decrease in your credit limit. But it is not always about your credit behaviour that affects the limit. Sometimes the lending policies of a particular card may change and lead to a fall in the limit of that particular card. If that is the case, you may opt for an upgraded card and avail a higher credit limit in case of need. Banks may also have several other reasons for lowering your card limit. For example, a longer inactive card etc.
Should You Opt for a Higher or Lower Limit?
Higher Credit Limit
Pros: It is more flexible in case of major purchases. It could help your credit score if it lowers your utilisation rate. It could stand as an emergency safety net. You can easily make payments for big purchases with just one card without using multiple payment tools.
Cons: High debt can easily be built up if one is not careful in handling and using it which later can translate to higher financial burden with interests.
Unchanged Credit Limit
Pros: It curbs impulsive spending which becomes unmanageable quite easily. It also aids easier budgeting and financial planning if your spending is limited to only a fewer things.
Cons: If you are an impulsive buyer, it may tempt you to spend more and if you fail to repay the same on time it may add up to your monthly costs. Habitually delaying payments may also impact your credit score negatively
In conclusion, your credit limit is important andin case of any changes in your financial position, let your card issuer know. The issuer may find it feasible to realign your credit limit. A good financial health can be maintained by knowing and managing your credit limit. Handle your credit responsibly and pay your bills on time.
(The author is CEO, Bankbazaar.com)
Disclaimer: Views expressed are personal and do not reflect the official position or policy of FinancialExpress.com. Reproducing this content without permission is prohibited.