When creditors grant you access to credit or lend you money, they will generally put a cap on that amount, depending on many factors such as your credit score and your debt-to-income ratio. This is what is called a loan limit or borrowing limit. In the instance of credit cards, it is referred to as the credit limit.
Every type of credit card will come with a credit limit, which is the amount of money you are only allowed to borrow and make use of. But, with all the benefits that credit cards bring, sometimes we just lose touch with our spending.
So what happens, if you keep using your credit cards, to pay for purchases or services, to the point that you reach- and in some cases, even go over- your credit card’s credit limit?
In this article, we will go over exactly just that: What happens when you exceed your credit card’s credit limit, and the impacts of exceeding credit limits on your credit scores.
What Is A Credit Limit?
In the world of crediting and lending, the term credit limit refers to the amount of credit, or money, a financial institution, and other lenders, such as banks, will extend to a borrower for a particular line of credit.
For credit cards, a credit limit is the maximum amount that you can charge on a credit card. In contrast to other credit limits, however, with credit cards, you are given a revolving-type of credit. Meaning, you can borrow against the credit limit and pay it back whilst keeping the account open.
In simple terms, you can use a credit card up to its credit limit, pay the balances down, and borrow again- with no predetermined payoff date and until the account is closed.
What Determines My Credit Limit?
As mentioned above, your credit card account’s credit limit is determined by a different number of factors. Generally, this credit limit is set by your credit card issuer after considering three basic factors.
Credit Reports and Scores
Your credit history, more specifically, how you have handled your past credit, is a major factor used by credit card issuers to judge how much they will allow you to borrow. Your credit is used to determine how likely you are to pay back a debt or a loan.
Typically, the more positive your credit history and credit score, you will be perceived as a low-risk borrower to default. Thus, increasing your chances of being granted a higher credit card credit limit. In reverse, If you have poor credit, or in some cases, none, you will be less qualified to be granted a credit card, much less a credit card with a higher credit limit.
Debt and Income
While your credit history and credit score do play a larger role in your credit limit, your financial circumstances also affect it. When determining how much a credit card issuer will let you borrow, they will generally also consider your income, your existing debts, and any and all financial obligations and commitments.
Your debt, in relation to how much your income is, affects how much a credit card issuer will be willing to set your credit limit as. Simply put, they would want your credit limit to be at where you can make your payments regularly.
To calculate your debt-to-income(DTI) ratio, you simply need to sum up all of your monthly expenses and divide it by your gross monthly income. For example, if your total monthly expenses amount to $1,000 and your gross monthly income is $5,000, then your DTI ratio is 0.2 or 20%.
Issuer’s Internal Factors
There might be cases where you may have a positive credit history and credit score while also may have a low DTI ratio, but may receive a credit card credit limit that is low. Simply put, it is not only the borrower’s circumstances are considered, but also the lender- in this case, the credit card issuer.
The credit card issuer may extend a credit limit that is higher or lower depending on how much money they are comfortable granting. It is also worth mentioning that, credit limits may come predetermined depending on the type of credit card, such as with secured credit cards- where the credit limit equals the security deposit.
What Does It Mean To Exceed Your Credit Limit?
Typically, credit card issuers will only allow a cardholder to charge a credit card up to its limit and not more. This refers to ‘maxing out’ your credit card. However, depending on the credit card issuer, you may be able to spend more than the credit card’s credit limit.
Normally, with most credit cards, you will not be able to charge on the card any more if the limit has been reached, and will result in the card’s declination. But, if the credit card issuer allows for it, you may be able to go over your credit limit without the transaction being declined.
Generally, credit card issuers will allow borrowers to exceed their credit limit if they have had a history of managing the credit card account responsibly. Some credit card issuers also provide an option for over-limit protection- which allows cardholders to charge more than their credit limit.
How Exceeding Your Credit Limit Affects Your Credit?
Credit scores are determined by using the information in an individual’s credit report. The largest factor affecting your credit score is your payment history. Your history of making payments on schedule and on time accounts for 35% of your credit score.
But, while paying for your credit card’s balances is indeed important, credit cards mostly affect the second largest factor in credit score calculations- which is Credit Utilization. Your credit utilization refers to how much credit you are currently using compared to your credit limit.
For instance, if you have a credit card with a balance of $1,000 and a credit limit of $5,000, then your credit utilization ratio is 0.2 or 20%. While there is no official guideline as to what constitutes a high credit utilization ratio, most credit card issuers prefer to see a utilization rate of 30% or lower.
Meaning, if you go over your credit card’s credit limit, you are essentially raising your credit utilization ratio- which in turn, hurts your credit score. Credit utilization, or the Amounts you owe, accounts for 30% of your credit score- making it the second-largest factor impacting credit scores.
The Bottom Line
While some credit card issuers allow cardholders to exceed their credit limits, it is generally not advised. Going over your set credit limit can and will hurt your credit score- making it more difficult to qualify for other credit, such as a mortgage or another credit card.
Make sure to only charge what you need and pay it back in full before the next billing cycle of your credit card. However, if your past credit card behaviors have caused your credit score to decline, you need to get it fixed. Call us at 888-799-7267 to schedule a Free Credit Consultation.
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