Investment Glossary – Credit Limit
When I was a child, my parents kept me on a pretty strict bedtime routine. During my elementary school years, I was usually in bed at 8:00 P.M., though I’d occasionally be able to weasel an additional hour or so out of them if there was a big sporting event or something going on that I wanted to stay up for. Now, you might think this sounds pretty strict, and it sure seemed like it to me at the time. But there was also a good reason my parents kept me on this strict schedule – I was a huge pain in the ass and generally grumpy as hell if I got off that schedule for any extended period of time. Why am I telling you this in an article that’s supposed to be about credit limits? Because the principle of a credit limit is the same – banks and other lenders are going to restrict the amount that you can borrow, because until they know you better or prove otherwise, they assume you’re going to be a pain in the ass in terms of losing them money if you end up borrowing too much.
A credit limit is the maximum amount that a bank or other lender makes available to you. This limit is commonly found on a credit card, home equity line, or personal lines of credit. So let’s say that I see a card out there offering a huge sign-up bonus in the form of a bunch of miles for my favorite airline. And let’s say I do the math and the card makes sense for me to get. When I apply for the card, the issuer is going to pull my credit score, which gives them information about my borrowing history, and they’ll also ask for some information from me, such as my income and job. Based on those factors, they’re going to assign to me a maximum amount that I can borrow on that credit card.
When you get your first credit cards, your credit limits tend to be pretty low. If you’re an 18-year-old kid who just started college and has never been in the credit system before, you might only be able to get a card with a limit of $500 or $1,000. Likewise, if you’ve had trouble with credit cards or other types of loans in the past, banks may be hesitant to extend a large line of credit to you because they don’t want to take the risk that you can’t pay that money back. Then, they could end up on the hook for the new shoes and Xbox you bought last year. Banks don’t want your Xbox.
But as you start to establish a longer credit history and boost your credit score, banks and other lenders may start to view you as more trustworthy. This allows them to offer larger credit limits to you, and eventually to consider you for things such as a mortgage or car loan. Even there, there’s often a credit limit that’s established – when you’re in the mortgage underwriting process, banks will effectively give you a maximum amount that you can borrow for a home. You’ll be tapping into those funds immediately to make the purchase, but they aren’t going to let you borrow willy-nilly until it gets to a point where you can’t pay the loan back. Their goal is to make money on the loan, not own a house they repossess and have to flip.
One item to keep in mind is that credit limits may be negotiable in certain cases.
If you feel that your borrowing history warrants a higher limit, or maybe your income has changed since you opened your line of credit, many credit card issuers allow you to petition for an increase to your credit limit. You are not guaranteed to be approved for the additional credit, but it is something to be aware of if you are trying to build towards higher purchasing power on credit cards.
So those are the basics of how a credit limit works. It’s the maximum amount of money that a credit card issuer or other lender will allow you to borrow on that line of credit, and it’s largely done to protect those issuers from potential losses. As you build better credit and a longer history, those limits may be increased, and you also can have the ability to petition for an increase yourself down the road as well. So don’t take it personally if when you’re starting out, you have to work with a low credit limit to begin with. It’s just because the bank doesn’t know you and doesn’t want to have to solve problems for you if things break down and you can’t pay your debts.