By : William Briat
We all know that credit cards come with a credit limit. The credit limit is the maximum amount that you can charge on a credit card. The credit limit is set by the issuing party after taking into account several factors including,
One of the most important factors that lending institutions take into account while setting up the limit on a credit card is the credit score. In fact, credit scores play a very important role in getting any kind of debt, whether it is mortgage, auto loans, and student loans. Credit score is a three-digit number which is an indicator of the creditworthiness of an individual. Credit score is derived after a credit report is prepared – a credit report summarizes the financial history of an individual to assess his creditworthiness. There are several organizations that prepare credit reports and come up with a credit score for an individual, but the most widely used credit score is the one that is calculated by FICO. There are several parameters on which an individual’s FICO score is calculated such as amounts owed, length of credit history, types of credit used, and payment history. Usually, the credit score is in the range of 300 to 850, with 300 representing absolutely poor credit history and 850 representing an impeccable credit history. A score of above 700 is considered to be good by most private lenders. So, while determining the limit on your credit card, the banks factor in your credit score. Higher the credit score, greater your credit limit.
Well, it is quite indubitable that your personal income will have a major role to play in deciding your credit card limit. Banks and other lending institutions put a lot of emphasis on the personal income of the applicant. After the 2009 Credit CARD Act, it has become mandatory for applicants to divulge the details about their personal income. Before the act was passed, credit card lenders used to decide the credit limit on the household income of an applicant. However, as was widely reported, this system was abused, especially by youngsters, who used to receive higher credit limits on account of their household income, but their personal income did not suffice to repay the charges they had racked up. Today, all lenders look at the personal income of the individual before deciding the eligibility and the credit limit.
Credit card companies make money through the interest rates that they charge you. To assess the risk of lending money to an applicant, credit card companies check the repayment history of an individual. Although most of the times, banks and lending institutions will simply pull up the credit report of an applicant, sometimes the repayment history is checked to be doubly sure about the risk involved in lending. If an applicant has a clean repayment history, i.e. he has never missed a payment, there is a likelihood that he will be given a high credit limit compared to someone who has a record of missing payments or making late payments.
We discussed how personal income plays an important part in deciding what limit you get on your credit card. However, sometimes, the personal income might not be a true indicator of an applicant’s creditworthiness. Let us take an example to understand this. Suppose Joe makes $5,000 per month and Jake makes $4,000 a month. Joe has a mortgage, two credit cards, and a car loan to take care of, which leaves him with a disposable income of only $1,000. Jake, on the other hand, has only one credit card debt, which leaves with a debt-free income of $2,500. Who do you think is more likely to get a higher credit card limit? Well, if we don’t take into account the other factors, and make the decision on the debt-to-income ratio only, Jake will definitely end up getting a higher limit than Joe. This is one of the prime reasons why most lending institutions take debt-to-income ratio into consideration while setting the credit limits.
These were some important parameters that banks and lending institutions take into account while deciding upon the credit limits of applicants. One important thing that you should remember is that credit limits are not cast in stone; a lender may decide to give you a lower limit, observe your spending and repayment habits for some time, and depending upon how well you manage your debts, he might actually increase your credit limit. Concluding, we hope that this article helps in clearing some ambiguity over how credit card limits are determined.