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Have you ever wondered about the science behind your credit card limit? Why do people of the same age and same income get different credit limits? Have you ever wondered why your friend was able to get a high credit limit while you were approved only for a smaller limit on the same card? In this article, we walk you through the basics of credit limits and shed light on how credit card companies determine the credit limit. Let’s get started.
What is a Credit limit?
The credit limit, as the name suggests, is the purchase limit set by the credit card company or a bank on a particular credit card. The limit is the maximum amount the user can spend using his/her credit card.
For example, if your bank provides you with a credit card with a limit of Rs.60,000, you cannot spend beyond this amount on a single transaction. The credit limit varies based on the type of credit card and is decided for customers based on their eligibility.
How do Banks determine the Credit Card Limit?
Your bank determines your credit limit when you apply for a credit card. This is done by taking multiple elements into consideration. These include:
- Your age
- The debts you currently have (home loans, car loans, personal loans, education loans, etc.)
- Your annual income
- Your employment status
- The amount of credit in your name
The credit limit is determined by two major factors.
- Your credit score
- Your credit history
If the card you are applying for is your first credit card or you don’t have any credit to your name, then you can mostly expect a low credit limit. This is because the bank does not know exactly if they should take a risk on you or not.
On the bright side, a low credit limit doesn’t stay low for a long period of time. If you use your card often and make your payments on time and in full, the bank will offer to increase the credit limit on your card, only if you want to.
Additional Reading: How to increase credit card limit
Why does the credit limit depend on your credit score?
While there are several factors that determine your credit limit, the credit score plays a crucial role. A credit score is a 3-digit number ranging from 300 to 900. Banks and credit card companies use this number to determine your creditworthiness. The higher the score, the better it is.
When you have a high credit score, it shows to the lender that you’re responsible when it comes to handling credit. It reflects your past credit repayment history. Credit card companies prefer applicants with a high credit score, as they’re less risky. So, having a high credit score helps you secure a larger credit limit on your card.
Besides, the credit score, there’s another factor that plays a crucial role in determining your credit limit. It’s the credit utilisation ratio.
What is the credit utilisation ratio and how does it impact your credit limit?
Your credit utilisation ratio is a measure of how much of the available credit you tend to use. It’s a widely used ratio that is used to calculate the current amount you owe on your card compared to the total credit extended to you and is expressed as a percentage.
If your utilisation ratio is considerably high every month (i.e., the amount you spend is close to your total credit limit), lenders will naturally think of you as credit hungry. They also assume you are not trustworthy enough as you won’t be able to manage your finances and hence may default on payments. This, in turn, affects your credit score making it that much harder for you to get a loan or secured credit cards with a high limit.
However a low credit utilisation ratio, on the other hand, means that you know how to manage your income and expenditures. It also shows that you will be able to pay your bills in full and on time.
From a lender’s point of view, you are deemed trustworthy. In other words, a low credit utilisation ratio will most probably lead to an increase in your credit score. This makes you more likely to get a credit card with a higher limit. It is usually advised that you keep your credit utilisation ratio under 30%.
Here is an Example to Understand the Credit Utilisation Ratio:
Your credit card from XYZ Bank comes with a total credit limit of Rs.60,000. In the month of June, you use Rs.45,000 from your card. You are safe since it is within the credit limit.
The credit utilisation ratio, however, is 70% [(45,000/60,000) x 100]. This is much higher than the expected average percentage. Note that this is how a high credit utilisation ratio could adversely affect your credit score, which in turn, makes it difficult to get a high credit limit on future cards.
Additional Reading: How to Get a Good Credit Utilization Ratio
Conclusion
The credit limit provided on your credit card is the maximum balance set by the issuance company. By setting a credit limit, the bank controls your purchasing power with the card. Various credit card issuers have various criteria for calculating the credit limit to be granted to an individual applicant. The two major factors that determine the credit limit available on a card are the credit score and credit utilisation ratio. Being aware of the factors that determine your credit limit can help you make informed decisions, and handle your card smartly.