When you apply for a credit card, a couple of things will happen. First, the issuer is going to pull your credit so it can get an idea of whether you’ll be a good borrower. If it decides to issue you a credit card, you’ll be assigned a credit limit.
What’s a Credit Limit?
It’s the amount of money a credit card company will allow you to borrow at any one time. There are several different factors that are considered when assigning a credit limit, but a big one is your credit score. (The other big one is income.) Someone with excellent credit has proven they can borrow money and pay it back on time. This person is likely to receive one of the higher credit limits allowed. However, if you have bad credit or not much credit at all, you might not be quite so lucky. You might even be limited to applying for a secured credit card, which requires you to put down a cash deposit that serves as your credit line.
Time for an Upgrade?
Let’s assume you’re an average borrower, and your credit card has an credit limit of $3,500. You find out that your house needs a new roof and it’s going to cost $7,000 to replace. While you have a $5,000 emergency fund, you don’t want to use the entire amount. Unfortunately, because of the credit limit on your card, you’re not going to have much choice unless you ask your credit card company to increase your credit card limit.
But is it a good idea to ask for one? Let’s go over the pros and the cons.
What Are the Benefits of a Credit Limit Increase?
It should lower your credit utilization ratio. Your credit utilization ratio, or the amount owed compared to your credit limit(s), is the second most important factor among credit scores. If you were to max out your card, your credit utilization ratio would be 100%. — and very, very bad for your credit score. It’s generally recommended you keep your balances below at least 30% and ideally 10% of your total credit limit, so asking for a credit limit increase could put you closer to those thresholds, which should help your credit score. (You can find 10 more tips for improving your credit here.)
It can be your rainy day fund. Not everyone has an emergency fund set up when an unexpected expense pops up. (In fact, most Americans do not.) When this happens, it’s nice to have a credit card with a higher credit limit. You can use your card to cover the expense, but will hopefully still be able to keep some breathing room between the balance and your credit limit.
You’ll receive added benefits on large purchases. Are you planning to purchase a big-ticket item in the near future? How about a new refrigerator or washer and dryer? If so, there are perks to having a higher limit. It’ll allow you to put these expenses on your credit card, either because you’ll have the extra credit or you’ll have a bigger buffer when it comes to your credit utilization. As such, you’ll not only earn rewards, but also receive several consumer protection perks. Many different credit cards come with purchase protection, price protection, and an extended warranty. Note: The rewards strategy is best employed when you can pay your balance off in full by the end of the month; otherwise, you’ll lose those points, miles or cash back to interest.
What Are the Drawbacks of a Credit Limit Increase?
You might not want the hard inquiry. Each time you request a credit limit increase, your card issuer will most likely pull your credit report. The purpose of this is to make sure you do not have other large, outstanding loans that will make it difficult to pay your bills on time. The credit pull will result in a hard inquiry, which will affect your credit score by a few points. However, the effects shouldn’t last long — hard inquiries stay on your credit for two years but only affect your scores for 12 months. If you already have less than ideal credit and are concerned about reducing your score any more, requesting a credit limit increase might not be the best move. (Not sure you can take a hit? You can view two of your credit scores, updated every 14 days, on Credit.com.)
You can’t be trusted. There are certain people that just can’t trust themselves with additional money. If they have access to a higher credit limit, they see it as a reason to spend more. If this is your reasoning for getting a credit limit increase, it’s probably a good idea to put off the request.
Image: PeopleImages
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