Why a higher credit limit than needed?


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Dear Credit Card Adviser,
Since keeping your credit card balance at 50 percent of your “credit limit” is recommended, why isn’t 50 percent of your “credit limit” your actual credit limit?
— Stephen

Dear Stephen,
You can borrow against your full line of credit, but that may not be the best course of action for your credit score.

What an existential question when it comes to credit cards! All joking aside, your credit limit isn’t half because you can borrow against your full line of credit. That may not be the best course of action for your credit score, but the reality is that amount is available to you, especially in emergencies.

The credit limit is also not an arbitrary number. Issuers don’t just give out any credit limit. They use varying methods to determine what credit limit is best for a particular applicant.

The simplest way is assigning one credit limit to a specific card, so if you qualify for the card, you get that one preset credit limit. Other issuers offer a preset range for a credit limit. That means if your credit score is on the lower end of the qualifying range, you’ll likely wind up with a limit on the lower end of the preset range. Lastly, some issuers use a complicated calculation using many variables such as credit score, income and debt-to-income ratio to come up with a customized credit limit.

What all this means is that issuers believe you can handle the full credit limit, even if you don’t use it. In fact, if you use much of your credit limit every month but pay off your balance in full all the time, this tells issuers that you can handle a larger credit limit and they offer an increase.

If you find that you’re using too much of your credit limit and are worried about your credit score, then consider requesting an increase or opening another credit card to spread out the charges to achieve a low utilization rate, which is the percentage of available credit that you use.

You’re right that FICO, the most widely used credit score developer, wants you to use less rather than more of your credit limit to show responsibility. The utilization rate for each credit card and all your cards in total makes up 30 percent of your credit score. Consumers with the highest FICO credit scores — more than 785 — keep their utilization rates to 7 percent, on average.

But, at the end of the day, if you need to charge $4,000 on a card with a $5,000 limit for some unforeseen circumstance, you can do that. A FICO score won’t prevent that. What will happen is your credit score will probably be lowered until you pay off the balance and go back to your usual financial habits of only charging half or less (rule of thumb: less than 20 percent) of your available limit.

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