A credit limit is the maximum balance you can carry on your credit card at any one time.
Each purchase you make on your credit card reduces your credit limit accordingly.
Once you reach this limit, you can’t charge further purchases until you apply a payment toward your balance owing, which frees up credit space.
If you attempt to exceed your credit limit, your transaction will decline to process or incur an over-limit fee, depending on your card issuer’s policy.
How is Credit Limit Determined?
All credit cards come with a credit limit, but no standard amount applies to each cardholder.
Instead, card issuers assign them based on various factors, most of which pertain to your finances.
Below are the most prominent ones:
- Credit Score.
The higher your score, the larger the credit limit you can expect to receive.
- Payment History.
Your payment history includes details that show whether you pay your bills and debt payments on time.
- Current Debt Obligations.
The amount of debt you presently owe can impact your ability to service your credit card payments.
- Average Age of Accounts.
Experience matters when it comes to managing debt. The longer you’ve maintained your existing credit accounts, the more likely you’ll receive a high borrowing capacity on your card.
- Income and Employment Status.
Naturally, your card provider wants assurances that you have sufficient income to cover your payments.
How does Credit Limit work?
A credit limit is a prominent attribute of revolving credit products, including credit cards and credit lines.
A revolving credit product allows you to continuously borrow funds at your discretion up to your account’s pre-set credit limit.
When you conduct a purchase using your credit card, your card issuer subtracts the corresponding amount, shrinking your available credit limit.
When you pay back the amount owed, it’s available for you to use again.
You don’t need to reapply each time you wish to draw funds.
Suppose your lender issues you a credit card with a $10,000 credit limit near the beginning of March.
You charge $4,000 worth of purchases to your card during the month.
Once your March billing cycle ends, your lender sends you a statement showing a balance owing of $4,000 with a deadline of February 10.
Your credit limit has dropped by $4,000, leaving you with $6,000 worth of spending power.
You decide to apply $3,000 against your balance before the deadline expires, meaning the remaining $1,000 will carry over to the following billing cycle.
As a result, your spending power increases to $9,000 ($6,000 + $3,000), which is the amount you can charge freely to your account.
Depending on your card issuer’s policy, cash advances, interest, and fees reduce your credit limit in addition to purchases.
Frequently Asked Questions
- Is a high credit limit good?
A high credit limit may be beneficial or detrimental, depending on your spending habits and ability to handle debt responsibly.
The more credit you have, the more flexibility you have regarding spending power, especially during financial emergencies. With more credit at your disposal, it’s also easier to maintain a low credit utilization ratio, a significant component of your credit score.
However, if you’re prone to overspending, you can quickly rack up an excessive amount of debt with a generous credit limit, leaving you struggling to keep up with your payments.
- Is credit limit based on income?
Your income affects the credit limit on your credit card, but it’s only one of many factors your lender evaluates when they evaluate your credit worthiness.
Other aspects they consider are your credit score, payment history, current debt load and the average age of your credit accounts.