Credit companies have become more cautious when issuing new credit, and some banks are even cutting credit for people with inactive accounts and increased credit risk. This can have important and costly ramifications on your credit, so it is important to understand how scores are calculated and what your credit limits mean.
What are Credit Limits?
Credit limits are one of the most basic parts of having a revolving credit account. When you get a new credit card, the bank decides how risky you are and how much they would be willing to lend you. A college student with no credit history may be given a $500 limit, while a homeowner with a long history may get a credit line over $100,000. I have credit cards with limits as low as $1,000 and as high as $22,000.
Credit Use Ratio
The most important impact your credit limit has on you on a day-to-day basis is its part in the credit usage ratio. Your percent of credit used is calculated by adding up all of your credit card balances and dividing that into your total available credit.
Let’s look at an example. Say you have two credit cards. One has a limit of $1,000 and one has a limit of $5,000. Your total available credit is $6,000. One has no balance and the other has a balance of $500. Your percent of credit used is $500/$6,000, or 8%.
Impact on Your Score
Credit score calculations are very complex. Your percent of credit used is one of the factors that makes up your credit score. Your utilization percentage is part of the bucket that makes up 30% of your credit score. Keeping your credit balances low can quickly raise your credit score and help you build a good history. On time payment is the most important part of your score and your outstanding credit is the second most important part of your score.
How to Keep Cards Active
I once had a bank close one of my credit cards for inactivity. Having worked in a bank, I used to look at inactivity reports to decide which accounts should be shut down. It is really easy to avoid those reports.
To keep your account active, just use it every once in a while. I have around 10 open credit cards. I only use one every day. For the rest, I grab the stack a couple of times each year and buy lunch or gas or a small purchase on each card and pay it off right away. That keeps your account active, your limits high, and your ratio low.
How to Get Higher Limits
If you have a few cards with low limits, the easiest way to raise your total available credit is to ask. I have filled out the form at Citibank before and had an instant credit line increase of thousands of dollars. On an old MBNA card, I wanted a higher limit so I called and asked. They asked why I needed a higher limit so I told them I was planning a big trip and wanted to book everything on that card. They glanced at my payment history, which was flawless, and doubled my credit card limit on the spot.
New Credit Can Lower Your Score in the Short Term
One word of caution when seeking higher limits. New credit makes up 10% of your score. More new credit is considered a bad thing, so if you are planning on buying a home with a mortgage or seeking any new loan in the near future, hold off on getting new credit cards or submitting other applications.
If you do not know your score, you can get it for free at Credit Sesame.
Post originally published January 9, 2009. Updated September 13, 2013. Image by by Wonderlane / flickr.