A credit limit is simply the maximum amount you’re allowed to borrow on a given credit line, such as a credit card or line of credit. Credit limits themselves are not a scoring factor, but they influence your credit utilization ratio – which is an important factor in credit scoring.
This is because credit scores are partly based on your credit utilization ratio – the percentage of your available credit on revolving accounts you are currently using. The lower this ratio, the better chance you have of a high credit score.
Here’s how credit limits work, and how they can impact credit scores.
Key Takeaways:
- A credit limit is the maximum amount you can borrow on a revolving credit account.
- Every lender uses unique criteria to determine how much credit to extend to customers.
- Your credit utilization ratio – the percentage of all your revolving credit limits that you are using – impacts your credit score.
What Is A Credit Limit?
A credit limit is the largest amount of money that a lender or credit card issuer will allow you to borrow on your account. For example, if you have a $1,000 credit limit on a credit card, you can make purchases up to $1,000 on that card, and no more.
Whenever you use a credit card for a purchase, you tap into a portion of your credit limit on that card. So if you spend $500 of your $1,000 limit on that credit card, you’ve used 50% of your credit, and you still have $500 in available credit to spend. As your account balance increases, your available credit decreases. And you replenish your credit limit by making payments to your account.
Typically, if you’ve borrowed the maximum amount of credit you’re allowed on an account – aka your full credit limit – you must then make a payment to lower your balance before your card issuer will allow you to use the card for any additional purchases.
Here’s an example of how this process works:
- Credit limit on account: $5,000
- Total monthly charges: $5,000
- Available credit: $0
- Credit card payment: $2,500
- Updated available credit: $2,500
In this example, the entire $5,000 credit limit is reached in a single month. But after paying off half the balance, you regain half of your total credit limit for new purchases.
Types Of Accounts With Credit Limits
Both credit cards and other revolving lines of credit commonly feature credit limits. Some examples include:
- Retail credit cards (gas cards, department store cards, etc.)
- Home equity lines of credit (HELOCs)
- Personal lines of credit
- Business lines of credit
Credit cards and retail store cards are the most common accounts included in revolving credit utilization calculations. Some lines of credit, such as HELOCs or business accounts, may or may not appear on your personal credit reports depending on the lender.
Varying Credit Card Limits
Credit cards may have different maximum borrowing thresholds for different types of activity. Some credit cards also set separate limits for certain transactions, such as cash advances or balance transfers, within your overall credit limit. Each of the following credit card activities may have their own different limits:
- Purchases
- Balance transfers
- Cash advances
Check your credit card agreement to understand the separate limits, as well as differences in APR and fees, for each type of transaction.
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How Are Credit Limits Determined?
When you apply for revolving credit, the bank or credit card company will review your credit history to determine your credit limit. Expect them to evaluate the following:
- Credit score: Lenders look at your overall credit score to estimate how likely you are to repay new debt. A higher score may help you qualify for a higher credit limit.
- Debt-to-income (DTI) ratio: You have a high DTI ratio when your existing debt payments absorb a large portion of your monthly income. This could result in lower limits when you apply for new credit.
- Payment history: Consistent on-time payments signal you’ll continue to make timely payments on a new credit card – which could help you qualify for a higher credit limit.
- Employment status: Financial institutions want to make sure you have reliable income to keep up with future payments. They may also look at the broader economy and employment data when determining credit limits.
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Why Your Credit Limit Matters
Along with defining how much you can charge on your account, your credit card limit also impacts your credit scores. About 30% of a FICO Score is based on the “amounts owed” category, which includes your credit utilization ratio.
When you have low credit limits, it’s easier to overutilize your credit card accounts. And if your credit reports show a high percentage of utilization, that can drive your credit scores downward. So if you want to earn and maintain good credit scores, a low utilization ratio is critical. In general, the lower your revolving credit utilization, the better.
Check out the following two examples of credit card usage to understand how a low credit limit can be a disadvantage where your credit scores are concerned.
Example 1
| Credit Limit | Account Balance | Credit Utilization |
|---|---|---|
| $500 | $500 | 100% |
Example 2
| Credit Limit | Account Balance | Credit Utilization |
|---|---|---|
| $5,000 | $500 | 10% |
As you can see, the only figure that changed between Example 1 and Example 2 is the credit limit. The low limit in the first table resulted in a maxed-out account. Meanwhile, the high-limit credit card in the second table resulted in a much lower revolving credit utilization ratio, even though the actual spend was the same.
If all other factors are equal, the individual with the maxed-out account will likely have a lower credit score than the one with the higher credit limit. The deciding factor is the percentage of your credit utilization.
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What Happens If You Go Over Your Credit Limit?
Obviously, going over your credit limit is never a good move. When you exceed your credit limit, your revolving credit utilization ratio will climb to more than 100%.
Often your credit card company will simply deny your transaction if you attempt to charge more than the available credit limit on your account. In some cases, however, your transaction may be approved – but with consequences.
- You opt to receive over-limit coverage. Card issuers cannot charge over-limit fees unless you opt in to over-limit coverage, though they may still decline transactions that exceed your credit limit.
- Multiple transactions are finalized at once. You may exceed your credit limit if several pending transactions hit your account at once when your balance is close to the limit.
- Transactions post for higher amounts than your card issuer authorized. This can happen when transactions post for higher amounts than your card issuer initially authorized. For example, a gas station might authorize a charge of $1 when you start pumping gas, but once you fill up, your final purchase comes through as the full, higher amount.
Whether your credit card company allows you to exceed your credit limit or not, it’s something you definitely want to avoid. It may set off a chain of consequences that can include:
- Over-the-limit fee to your account (if you opted in for over-the-limit coverage)
- Decreased credit limit
- Increased interest rate
- Closed account (especially for repeat offenses)
- Decreased credit scores
- Less favorable terms on other credit card accounts
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The Bottom Line: Knowing Your Credit Limit – And Working Within It – Can Help You Achieve Better Credit Scores
Understanding how credit limits work and how they can impact your credit scores is an important part of being a smart borrower and credit card user.
The more knowledge you have about how credit cards operate, the more prepared you will be to make sure the credit cards in your wallet or digital wallet are working for you, not against you.
Wondering how your credit could impact your future mortgage? Use the Quicken Loans Mortgage Calculator to explore different interest rates based on your own credit score.
Lauren Ward
Lauren Ward is a writer with over a decade of experience covering financial topics for businesses and publications. Her work has also been featured in major publications such as U.S. News and World Report, CNN, Business Insider, The New York Post and Bankrate. Her expertise includes real estate, mortgages, small business, insurance and more.
