How is My Credit Limit Determined?
Creditors consider a variety of different factors when establishing credit limits, but the two most important pieces of information are your credit history and disposable income. The former tells them how responsible of a borrower you’ve been to date as well as how much debt you’ve incurred and the latter tells them how much additional credit you can comfortably afford.
The bottom line is that lending is about risk, and the institutions putting up the money want to minimize the chances that their customers will ultimately find themselves unable to pay back what they owe.
Of course, there is a lot more to how a credit limit is determined than just that. At the end of the day, it’s all comes down to overall profitability for creditors, so let’s analyze the various components that banks consider when determining how much money they can make off of you and thus what credit limit they can grant you.
The golden rule of credit underwriting is to make sure that the borrower’s income and assets will enable them to pay for what they spend given their existing debt obligations and other liabilities. You can think about it like this: A department store isn’t going to let you buy a new suit if you don’t have the money to pay the retail price it commands, and the only difference with credit is the fact that your payments are made after the fact.
Creditors therefore base your credit limit on the minimum monthly payment that you can comfortably afford to pay given your disposable income. For example, if your disposable income is around $100 per month and your credit card company requires a minimum payment of 4%, then your credit limit will likely be in the $2,500 range ($2,500 x 4% = $100).
Your credit history – the information in your major credit reports – reflects your financial responsibility as well as the length of your money management track record. The more dependable you’ve proven yourself to be in satisfying financial agreements, the more credit you’ll be eligible to receive moving forward (assuming your income can sustain it).
The following graph will give you a sense of what type of credit limit you can expect to receive based on your credit score (i.e. your credit history expressed as a number) and gross income level.
At the end of the day, it’s all about the bottom line for banks and other lenders. They determine the credit lines and products that you’re eligible for based on how much they stand to make from the relationship. Your credit history and disposable income have a lot to do with how they gauge potential profitability, but those aren’t the only metrics that they consider.
Most creditors also use consumer analytics to compare your applicant profile to historical data about how other applicants with similar financial habits and earnings expectations have fared. This enables them to gauge things like:
- Fee Potential: If you have a history of regularly incurring (and paying) service charges, interest, and other fees, this may appeal to creditors with dollar signs in their eyes.
- Attrition: Financial institutions are also able to estimate the length of time they can expect to have you as a customer. They may be more inclined to offer you a higher credit limit if you’re typically brand-loyal and have a preference for handling many types of financial transactions through a single bank.
- Likelihood of Recovery: Creditors are not only able to gauge how likely you are to experience major financial difficulties in the future, but also the chances that they’ll be able to recoup the money that you owe them should such difficulties arise.
While most credit cards will clearly disclose the credit line that is available to you, it’s important to understand that’s not always the case. Certain cards have a feature known as No Preset Spending Limit (NPSL), which means their spending limits change on a monthly basis in light of the economic landscape as well as changes in your spending and payment habits.
Many people mistake NPSL with having unlimited credit. All credit cards have spending limits, though. The only differences between a card with a transparent credit limit and one with NPSL is that you won’t know what your limit is and you may unnecessarily incur credit score damage based on how NPSL limits are reported to the credit bureaus.
With that said, creditors regularly review accounts in order to determine eligibility for credit limit increases and decreases. If you believe you are eligible for an increase, you may want to simply ask for one. But keep in mind that certain creditors may be receptive to this, while others will view it as a sign that you are desperate for money and will therefore hold it against you.
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