With great power comes great responsibility. And since it is very easy to be irresponsible and reckless when one is high on the power of a Credit Card, the concept of a Credit Limit was introduced. A Credit Limit is the maximum amount of credit one is allowed to borrow within a Credit Card cycle. Once you have maxed out your credit limit, the power of your Credit Card will cease.
Ideally, one should not use more than 30% of the credit limit. Otherwise, they would be perceived as credit hungry and someone who is living off credit. The amount of credit one uses in a cycle compared to the credit limit is called the credit utilisation ratio. If you utilise more than 30% of your credit limit, your credit utilisation ratio is considered to be high.
The following are the ill-effects of a high credit utilisation ratio:
- It lowers your Credit Score as your credit utilisation ratio plays a part in your Credit Score calculation.
- Banks may increase the interest rate on your Credit Cards and Loans as they perceive customers with high credit utilisation to be more prone to Credit Card payment default.
Additional Reading: Surviving A Credit Card Default
Now, if you are someone who extensively uses Credit Cards and manages to clear all Credit Card bills on time, then a high credit utilisation can affect you deeply. In order to reduce the credit utilisation ratio, one can increase the credit limit. Banks update the credit limit from time to time by analysing your payment history, rise in income, and loan defaults, if any. Alternatively, you can either ask the bank to increase your credit limit or you can apply for another Credit Card which will lead to an increase in your credit limit.
Here are some benefits of a credit limit increase:
- As mentioned above, your credit utilisation ratio is inversely proportional to your Credit Score. Since an increase in your credit limit decreases your credit utilisation ratio, this automatically improves your Credit Score.
- In times of financial emergencies like hospitalisation, a Credit Card with a high credit limit can cover a majority of your medical bills. A high credit limit can come in handy during any monetary crisis.
- And obviously, a higher credit limit allows you to buy high-value goods which you might not be able to otherwise pay off in one go.
Additional Reading: All About Your Credit Score
A rise in your credit limit has its disadvantages too:
- A high credit limit could lead to reckless spending. This would defeat the main purpose of a credit limit increase i.e. to reduce the credit utilisation ratio.
- A high credit limit could lead to higher Credit Card expenditure, followed by the inability to pay the entire amount on time. Once you carry over a balance to the next cycle, you are liable to pay high interest on it.
- In case of Credit Card fraud or theft, the loss incurred will be more if the credit limit is high.
Now that you know what a credit limit is and how it could affect you, weigh the pros and cons before increasing the credit limit on your Credit Card. Happy swiping!