How Your Credit Limit is Determined

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By Bethy Hardeman

The number that tells you how much you can charge on your credit card is known as your credit limit. It's a dollar amount that's set by your lender when you get approved for a new line of credit. But just how do lenders set these limits? For the most part, there are two primary factors that most lenders look at in order to set your initial credit limit: your credit score and income level.

1. Credit score

Your credit score is composed of six factors, in order of significance:
  • Credit card utilization rate: This is the overall percentage of credit limits you're using (calculate by dividing your total credit card balances by your total credit card limits). Typically, the lower this percentage, the higher your credit score.
  • On-time payment history: This shows how often you've made your bill payments on time. The closer this number is to 100 percent, the higher your credit score.
  • Age of credit history: This shows how long you've been building credit. In most scoring models, it takes into account both open and closed accounts. The longer your credit history, the more easily lenders can assess your creditworthiness.
  • Total number of accounts: This is the number of credit accounts you have on your credit report, including credit cards, mortgages, auto loans, student loans and personal loans.
  • Number of hard credit inquiries: Hard inquiries are initiated on your credit report every time you apply for credit. They typically fall off your report after two years. Too many recent hard credit inquiries can signify that you're desperate for credit.
  • Number of derogatory marks: Derogatory marks include accounts in collections, bankruptcies, civil judgments and tax liens. As one derogatory mark can significantly decrease your credit score, it's best to avoid them.
All of those factors boil down into a three-digit number (your credit score) that represents your creditworthiness and puts you into a credit rating category: poor, fair, good or excellent. Many credit cards have minimum credit score requirements, though these aren't always published by the lender.

2. Personal income

Your income also impacts your credit limit. Since your credit limit essentially tells you how much you can charge to your card, it's important for your lender to know you have the income to cover anything you charge.

Since 2009's Credit CARD Act, it was a requirement that applicants report individual income (instead of household income). This change was originally made to keep young adults from racking up credit card debt they couldn't pay off. However, it unintentionally kept stay-at-home spouses and partners from qualifying for credit. The Consumer Financial Protection Bureau lifted the restriction last month, and applicants can once again report household income.

Other things lenders consider:
  • Repayment history: Your credit score and income level don't always tell the full story; lenders are also interested in other factors. One factor is your repayment history. This shows how often you've paid back your debts on time. Credit card lenders want to see that you've been responsible with your other lines of credit in order to set the limit on your new line.
  • Debt-to-income ratio: Lenders typically take into account your debt-to-income –- or DTI -– ratio. You may have a high income, but if you're also in a lot of debt, you may not be able to pay off a maxed-out credit card. As a result, lenders may not want to risk giving you a high credit limit.
Your credit limit can change

Maybe you've been given a low credit limit to start. Don't fret! Your credit limit isn't set in stone. In fact, most credit card issuers will re-evaluate you as a customer every six months. If you've used your credit card responsibly, your issuer may decide to increase your limit.

On the flip side, if you've made some late payments or missed a bill, your issuer may find that reason enough to decrease your credit limit. A lower credit limit could inflate your credit utilization rate, one of the most important factors of your credit score.

Stay on track

After you get approved for a new credit card, use it wisely. Make at least the minimum payment on time each month (more if you can, to save on interest). And keep your credit utilization to less than 30 percent (but more than 0 percent) for a healthy credit score.

In no time, you should see your good habits pay off credit-wise.

Bethy Hardeman writes about personal finance, credit and the economy for CreditKarma.com, a free credit monitoring website that helps more than 20 million people access their credit score for free.


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How Your Credit Limit is Determined
Check your credit reports and correct errors. Of course, you want to make sure that everything is being accurately reported, from your current address to your closed accounts. (For more guidance on how to dispute an error on your credit report, look to this guide from the Federal Trade Commission.)

But you also want to check the details about what is being reported about your current accounts. For example, it can make a big difference to your score if your credit limit for a card is understated. Imagine that you owe $5,000 and your limit is $15,000. That means you owe 33 percent of your limit. If your credit limit is incorrectly listed as $8,000, though, it will look like you've borrowed 63 percent of your limit.
When you fix errors or take actions that should boost your score, make sure that all three of the main credit-reporting agencies (Equifax, Experian and TransUnion) know about it. By law, you can get a free copy of your credit report from each of them once a year -- do so, in order to spot errors and find other score-boosting opportunities.
One gambit few people think of is simply asking for what you want. In order to help you pay down your debt more quickly, you might ask your lender to lower your interest rate. If the lender refuses, see if you can find a lower-rate card and transfer the debt.

If you've got one or two glaring late payments on your credit record, you might ask your lender if they could be erased, in what's called a "goodwill deletion." Lenders are likely to be especially responsive to their best customers. And if you're dealing with a collection agency over some debt, see whether they'll delete it from your record if you pay it off. That can be well worth it.
If you're planning on closing some of your accounts, think twice. It's often a sensible thing to do to simplify your financial life, but closing an account can actually ding your credit score. One reason is that it actually reduces your available credit. Oddly enough, a host of seemingly sensible moves can hurt you -- such as using just one card for most of your charges. Even if you prefer using a newer card, keep older accounts open and use them occasionally to keep them active. Over time, that will give you a longer history and help improve that part of the credit score calculation.
Opening multiple accounts in a short period of time may boost your available credit, but it sends the wrong message to potential creditors, as it makes you look desperate to get credit from any available source.
Here's a valuable tip for anyone selling a home for less than they owe on it: What you're looking at is called a "short sale," and if you end up owing many thousands of dollars to your mortgage lender, you might get it in writing before the sale closes that the debt won't go on your record. Ending up with a big balance owed can be a black mark on your record, reportedly as costly as a foreclosure.

If a high credit score is important to you -- and for most of us it should be -- always consider how your financial actions will affect your score. For more information on credit scores, be sure to look at this guide from myFICO.com, which is the consumer division of the company that is responsible for the popular FICO credit score.
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