Credit limit, if managed well, is one factor that can be weighed and utilised to increase your credit score. It is the maximum credit that you are eligible to avail at any point from a lender. To get an easy reference, you can look at your credit card statement which includes your maximum credit limit.
More than your credit limit, the element that determines your credit score directly is your credit utilisation ratio. Depending on your credit limit and your utilisation of this credit, you can either get categorised as solvent or creditworthy or credit reliable.
An ideal credit utilisation ratio is between 30%-40% of the entire credit limit available and this accounts for about 30% of your credit score calculation. Not just that, this keeps your financial burden low and a well-balanced credit utilisation ratio will bring you a strong credit score. As a result, your ability to pick loans, achieve your financial goals and milestones will get better.
Your credit limit is determined at the time of applying for a new line of credit by the lender on the following factors:
- Credit report and credit score: It all boils down to that 3-digit score. Your lending bank checks your credit score before approving a loan or card, etc. This number tells them if your credit worthiness and risk. A higher credit risk will not necessarily mean that you will not get credit. It simply means that your collective credit limit will be lesser, or you will be eligible for smaller loans, and sometimes at higher interest rates.
- Current financial circumstances: The bank or lending institutions also check if you have a steady income, your bank statements to determine your cash flow and other obligations you may have.This will basically reflect your financial security. If your credit issuing bank sees that you have enough comfort in lending to you basis their analysis, then they may increase your limit. But if they see a reduced income or low balance in your account, then your credit limit could probably see a decrease as well.
What does it mean to go over your credit limit?
Considering that an ideal credit utilisation ratio is between 30% and 40%, you can imagine the impact an exceeded credit limit would have on your credit score. Not only will you put your credit score in jeopardy, you will also risk your profile coming across as highly credit hungry and bad financial management.
Now, if you are at 100% of your credit limit and you desire to make another purchase, it will be allowed only if you have a long history of responsible account handling. But after this, there are other significant consequences that you may face. They are as follows:
- Declined purchase: Your bank will allow an oversight once or twice, but not more than that. If you exceed your credit limit, then your transactions will get declined. This can be a difficult financial situation when you have limited options to make payments for your purchases.
- Extra costs: Some credit cards allow an over-limit protection, but the disadvantage is the fee that is charged for this privilege. This can be a problem considering that you have already crossed your credit limit and are charging more.
A low credit utilisation is attractive to the lenders and it positively impacts your score. On the other hand, a high credit utlisation, categorizes you as a risky borrower to the pool of lenders. In the hindsight, charging over your credit limit can also be an indication of a financial trouble which is fuming and that can make banks more cautious around your applications.
Once you have crossed your credit limit, make sure that your next expense is towards clearing your outstanding debt and not fueling more credit on your profile. One should act responsibly and cautiously when it comes to their credit limits. The credit utilisation ratio is of great importance to every individual as well as businesses. One must keep a close eye on it to make sure there are no long-term repercussions on your credit score.
Views expressed in this article are the personal opinion of Wilfred Sigler, Director – Sales and Marketing, CRIF India.