How to use your credit limit to your advantage

By Emma Lunn

Credit cards might let you spend money you don't have, but they don't give you a license to spend with reckless abandon. One of the restrictions credit card companies put in place is what's called your credit limit -- the maximum amount you're allowed to borrow.

It's easy to see your credit limit as a way for your card issuer to control you. Yet understanding your limit can give you some control as well -- and help you leverage it into a better credit score.

What is a credit limit?
Your credit card issuer will decide what credit limit you qualify for by digging into your financial history. Unpaid debts, current loans, your credit limit on other cards, your debt payment history (including missed payments) and your credit reports all paint a financial picture of your reliability. If you're a poor risk because you don't have a high enough income to service your debts or you've missed debt repayments in the past, credit card providers might offer you a credit limit lower than the one you applied for. credit-limit

If you charge more than your credit limit, be prepared to pay. Instead of denying the transaction, many banks will allow you to go over -- and then charge you a penalty fee. In 2006, the Office of Fair Trading announced that any penalty charges over £12 would be considered unfair and would be investigated. To avoid investigation, many banks capped their fees at £12.

That fee might not seem like a lot. Yet keep in mind that your bank might consider you in violation of your credit agreement -- and revoke any 0% balance transfer deal you have, or charge you a sky-high penalty annual percentage rate (APR). Moreover, maxed-out credit cards can wreak havoc on your credit scores.

The danger zone
Carrying a credit card balance close to your credit limit is almost as dangerous as crossing it. If your balance constantly hovers near your limit, you're hurting your credit because of something called the "credit utilisation ratio." That ratio refers to how much of your potential credit line you actually use.

Lenders like to see plenty of breathing room between your balance and your credit limit. This shows that you are able to keep your debt under control. While there's no consensus on a guaranteed safe amount of debt to carry, credit reference agency Equifax recommends not venturing above 30% of your credit limit.

What if I want a higher credit limit?
If you want to increase your credit limit to improve your credit utilisation ratio, you can simply ask your credit card provider for an increase. You'll have a better chance of success if you've had the card a while (at least three to six months), have stuck within your limit and have made payments on time.

"A key point of advice that will help in achieving an increase in credit limit is to demonstrate consistent management of the existing debt, paying off a good proportion of the monthly balance," says Neil Munroe, external affairs director at Equifax.

Yet having a high credit limit is generally not a good thing if you don't really need it. It won't necessarily boost your credit standing with lenders. In fact, it could make it worse, Munroe says. High credit limits allow consumers to get deep into debt and that could make a potential lender nervous. After all, if you decide to take advantage of your credit card's lofty limit, you might not be able to make your car payment.

"Increasing a credit limit may be seen as increasing your possible indebtedness and therefore could impact on you getting further credit elsewhere," Munroe says.

Controlling your limit
Even though sky-high credit limits could threaten your good credit standing, your bank might try to raise your limit anyway. This "reward" for good behaviour could lure you deeper into debt, which means more interest revenue for your issuer -- and a lower credit score for you.

In the past, issuers were allowed to raise credit limits and inform the cardholder after the fact. In 2010, the government reached an agreement with credit card companies and banks that limits this practice.

Today, banks and card companies must contact cardholders 30 days in advance and inform them that their credit limit is about to increase. Cardholders then have the option to opt out of the increase -- and to opt out of all future increases if they so desire.

Striking a balance
Using your credit limit to your advantage is a complex balancing act. If you're constantly scraping your credit ceiling, consider asking your issuer for a slight raise. Yet don't let your limit creep up so high that it becomes a red flag to other lenders.

Most importantly, don't look at your credit limit as a "target," or the amount of debt you can allow yourself to rack up. Your limit provides a useful guideline -- yet it's up to you to control your own spending so that it becomes a line you never cross.

See related: 6 things you need to know about overdrafts, Being too credit-shy can backfire

Published: 9 April 2012