Most credit cards have limits. When using any credit card, you should be aware of where your limit is and how close you are charging to it. If you charge above that limit, creditors can charge you additional fees, reduce your limit or even decline new charges.
But beyond that, exceeding your credit limit can also impact your credit score.
What exactly is a credit card limit? Simply put: a credit card limit refers to the maximum amount a credit card company or financial institution will allow someone to borrow on a single card. The credit card limit typically varies by individual, and is usually based on a number of factors including credit history, income, and previous credit behavior.
Credit card lenders may also set your limit based on other factors, such as the limits on your other credit cards, company policies, or special offers.
Why your credit limit matters
If you are not planning on making a large purchase using your credit card, you may wonder why you need a card with a $5,000 or $10,000 credit limit.
Even if you only plan to use a credit card occasionally, the credit limit matters because that will impact your credit utilization ratio—the amount of credit available to you vs. the amount that you use. This ratio varies by credit scoring model, but typically ranges between 30 to 35 percent.
Using all of your available credit may impact your borrowing history and your credit score because your credit utilization ratio accounts for 30 percent of your Equifax credit score.
For example, if you have a credit card with a credit limit of $1,500, charging a $500 plane ticket on your credit card will impact your credit utilization ratio more than if you if have a higher limit. Therefore, the lower your limit, the lower you may want to keep your balances.
Calculating your credit utilization ratio
In order to calculate your overall credit utilization ratio, add up all the credit limits on your open credit card accounts. Next, add up all the debt you owe on these accounts. Finally, divide your total debt by your total credit limit to obtain your credit utilization ratio.
For example, let’s say you have two credit cards, one with a limit of $500 and the other with a limit of $1,500. That means your total available credit is $2,000. Now let’s say you have a balance on the first card of $100 and a balance of $1,000 on the second card. The total you owe is $1,100, which is 55 percent of your total available credit. That is your credit utilization ratio.
Checking up on your credit habits
Here are a few ways that could help you move toward a healthy credit utilization ratio.
1. Keep an eye on your credit card accounts.
The simplest way to keep track of your spending is to regularly check your credit card balances. It’s also a good habit to periodically review your statement for errors that may have impacted your balances.
2. Create balance alerts.
Many credit cards offer consumers the ability to sign up for text message or email alerts that will send notifications when you’re getting close to your available credit limit.
3. Pay your credit card bill more often.
If you need to use a larger amount of credit than usual, you may want consider paying off your credit card more than once in a month in order to keep your debt low. If you are paid twice-monthly, it may be wise to also pay your credit card bill on each payday.
Payment history is a significant factor in determining your credit score, so try to avoid late payments. By paying your credit card accounts more often, you increase the likelihood that you will pay your bills on time and keep your credit utilization ratio in check.
4. Evaluate your accounts.
If you have old credit cards, you may want to consult a financial professional to see what you should do with them. Closing an account may decrease your overall credit limit and therefore increase your credit utilization ratio. Your credit score also factors in the length of credit history, and closing an older account could have an effect on this factor.
The credit limits on your accounts can make a difference in your overall credit profile. Take the time to review your credit utilization ratio regularly so that you know where you stand, and try to stay within the recommended limit for credit utilization, because your credit card limit is a factor in your credit profile.
Diane Moogalian is vice president of operations for Equifax Personal Information Solutions. Prior to joining Equifax in 2007, Diane held several strategic roles with leading financial services companies.
The information contained in this blog post is designed to generally educate and inform visitors to the Equifax Finance Blog. The blog posts do not give, and should not be assumed to provide, personalized tax, investment, real estate, legal, retirement, credit, personal financial, or other professional advice. Before making any financial decision, you should always consult with the appropriate professionals who can explain your options, rights, and legal responsibilities, and advise you on any tax, legal, credit, or business implications that may result from those decisions. The views and opinions expressed by the authors of blog posts are their own views and may not be the views or opinions of Equifax, Inc. and/or its affiliates.