Why Are Credit Limits Important And How Do They Affect Your Credit Score?

Ah, credit limits. The part of having a credit card – or another type of revolving credit account, for that matter – that we all want to know as soon as possible: how much can I spend/borrow in one go?

What your credit limit is set at can be the difference between being able to make that big purchase and not. Being able to handle an unexpected expense easily, versus, well, not. There are all sorts of reasons why what your credit limit is can be important to you. And, while that might be all that matters to you at first, there’s more to your credit limits than meets the eye.

As well as determining how much you can borrow at any given time, your credit limits also play a perhaps unexpected part in what your credit score is. But how? Let’s find out.

How your credit limits are worked out

When a lender decides what credit limit to assign to you, they look at your credit history and application information to help them work out what’s right for you. While making this decision, they take a few things into account:

• Your income and expenses – what’s left over after your existing monthly commitments lets lenders know roughly what you can afford
• The other accounts you have, like a mortgage, loans, overdrafts or other credit cards
• The credit already available to you through those other accounts, and how much of it you’re using (and therefore repaying) already
• Your repayment history – and specifically, whether you’ve missed any payments on other borrowing recently, or longer ago

The lender’s goal is to offer you a credit limit that you can afford the monthly payments for (don’t worry – they’re not looking at whether you could repay it all in one go!), and that based on your history, they’re confident you would keep up with the payments for.

How your credit limits affect your credit score

So, you know how your credit limit’s been worked out. But what does that mean for your credit score?

The amount itself

What your credit limit is says a lot about how much a lender thinks you can afford to repay, and how likely you are to repay it. And, we mean both from the perspective of the lender who’s set the credit limit, and from the point of view of other lenders who see your credit limits when they check your credit report. A high credit limit given by one lender shows others that you’re reliable, and present a low risk as a borrower. It can also indicate how able you are to handle any unexpected expenses. So, being approved for a relatively high credit limit of £4,500 or more can help to increase your credit score.

Credit utilisation

You might think that as long as you’re making all your payments on time, it doesn’t really matter what balance you’re carrying on your credit accounts from month to month. But, it does. Among the other things lenders look at in your credit report, they also pay attention to how much of your credit limits you’re using, also known as your credit utilisation. And, what your credit limits are in the first place can affect your credit utilisation quite drastically.

Let’s look at an example. Say you spend £200 on your credit card, to buy a new vacuum cleaner after yours goes kaput. If your credit card limit is £1,000, then as long as you didn’t already have a balance on that card, your credit utilisation will be 20%.

Got it? Let’s try another example. So, you’ve spent £200 on one card to buy a vacuum cleaner. The next week, your dishwasher floods the kitchen and can’t be repaired, so you need to spend £300 to get a decent replacement, and you decide to use a different credit card to buy it. This card has a credit limit of £500. Spending £300 on it puts your credit utilisation on that card at 60%.

But (and this is a big but), your overall credit utilisation is 33%. That’s because you’ve spent £500 between two cards, but the total credit available to you between those two cards is £1,500.

Shall we try one more? You’re having really terrible luck with appliances, because the week after you replace the dishwasher, your dog gets a bit too excited about a nature documentary and pulls the TV down off its stand! The replacement costs £500, but this time you decide to get it on finance from the shop. What does this mean for your credit utilisation?

In this situation, your credit utilisation is still 33%. That’s because credit utilisation is only applied to credit accounts where you’re given a limit you can spend as much or as little of as you like. If you have a “fixed sum agreement” like a loan or a finance agreement for a new TV, it doesn’t get counted towards your credit utilisation %.

One last one? Go on then. A month after all these shenanigans, the card provider you have the £500 limit with increases your credit limit – woohoo! The increase they give you bumps your credit limit with them up to £1,000. You still owe them £250 for the dishwasher, because like the reliable soul you are, you’ve already paid a bit off. You’ve paid £20 towards the vacuum cleaner off, too.

So, where does your credit utilisation stand now? You’ve now got £2,000 credit available to you between your two cards, and owe £430. That puts your credit utilisation now at 21.5%, and shows just how much your credit limits can affect the percentage!

What’s a good and bad credit utilisation?

When it comes to credit utilisation, lenders like to see you using the credit you have available to you… but not too much. We always say it’s best to repay anything you spend on your credit cards in full (and on time) when your bill arrives. But, if this isn’t doable – and sometimes it isn’t if you’ve had to make a particularly big purchase – then aiming to keep your credit utilisation at or below 30% is a good rule of thumb to follow. Having a very high credit utilisation – over 75% - can indicate to lenders that you’re relying on credit more than they’d like, and are perhaps struggling financially. If your credit card utilisation is higher than 30%, then making a plan to get your balances down, and following through with it, could help to improve your credit score. If you simply can’t, and you are struggling, then speak to your card providers – or an independent debt advisor, if you prefer – to get their advice and help to get your card balances paid off.

What does it mean if my credit card provider increases my limit?

If your credit card provider gets in touch to let you know they’re increasing your credit limit with them, then that’s awesome! Regular account reviews and credit limit increases are something lots of card providers do to reward their customers who have a solid record for making their payments on time.

Higher credit limits can help boost your credit score – both by acting as proof that you’re reliable and trusted when other lenders look at your credit report, and by decreasing your credit utilisation. If you’re offered a credit limit increase, it’s important to consider what any additional spending will mean for your credit utilisation, and to stay on top of it.

But, should you ever ask your lender for a credit limit increase if they haven’t offered one? Maybe, if the circumstances are right:

• Are you on top of your payments to this provider, and any others? If your credit history contains any missed payments, particularly recent ones, then a lender is likely to be reluctant to give you the opportunity to borrow even more.
• How’s your credit utilisation on the whole? If you’re keeping it well under control at or around the 30% marker, then this shows lenders you’re not asking for the increase out of desperation, and they may be more likely to say yes as a result
• Is your income the same – or more than it was when you applied? If your income has gone up and you can now afford more, then this can also help a card provider get more comfortable with offering you a credit limit increase. If you’ve recently taken a pay cut, though, then asking for bigger credit limits could mean stretching yourself beyond your means.

However, it’s worth bearing in mind that if you request a higher credit limit, rather than being offered one, the lender may run a credit check called a “hard search” on you that leaves a marker on your credit report. And, if you have a high number of hard searches in your credit report (3 or more in a 12-month period is considered a lot!), then this could suggest that you’re stretched financially and raise a red flag to other lenders you might apply to.

What if I want to decrease my credit limit?

If you have a higher credit limit than you’d like on your credit cards and similar revolving credit accounts, you might think that asking your provider to decrease it to the amount is the best thing you can do – after all, you’re taking responsibility for your borrowing by saying no when you think you’re taking on too much. But, while this might go down well with the lender in question, it may not do the same for your credit score.

If your credit limit decreases but your spending stays the same, your utilisation will go up, which could negatively affect your credit score. A decrease may also put you into the territory of the kind of low credit limit that causes lenders to think you can only afford a small amount, or that you have a chequered financial past that makes you a higher risk person to lend to. Again, this could have a negative impact on your credit score.

In most cases, holding onto your higher credit limits and simply only spending as much of them as you feel comfortable with is the best thing to do for your credit score. Your credit limits stay high, which shows you’re reliable and can afford to make substantial repayments, and your utilisation stays in a comfortable place, too. But, we know that for many people, having a higher credit limit comes with temptation to spend it and, if you’re not careful, can lead to overstretching yourself to the point of financial difficulty. If this sounds like you, then requesting a decrease could be the better thing for you overall, even though your credit score may take a hit.