Credit limit
Your credit limit is the maximum amount of money 💰 you can borrow on your credit card 💳. It's set by the credit card issuer based on factors like your income, credit score and credit history 📝 (previous borrowing/lending). A seperate credit score post is coming up next!
Exceeding 💥 your credit limit can result in additional fees and potentially damage your credit score. Most credit card suppliers allow you to adjust ↕️ your own credit limit. They tend to set the upper limit with what they are happy to lend you, but you can drop that credit limit to where you are comfortable with to restrict your own spending for discipline purposes.
Quite a few credit card suppliers actually automatically block 🚫 the transaction if you reach over the credit limit.
Credit utilisation ratio ⚖️ (now this is important...)
Credit Utilization Ratio (CUR) is a crucial metric for credit card users. It's calculated by dividing your total credit card debt by your total credit limit. For instance, if you have a credit limit of £1000 and you spent/owe £300, your CUR is 30% (£300 / £1000).
A low CUR (ideally below 30%) is generally seen favorably by lenders. It indicates responsible 🤓 and good at credit/debt management.
A high CUR (above 70%) can negatively impact your credit score, as it suggests you're heavily reliant on debt 😵💫.
It's important to note that while a low CUR is beneficial, having a zero balance on all credit cards isn't always ideal either. A small balance can help maintain your credit history.
Benefits of lowering your own credit limit
Use credit limit as a form of safeguard 🧱 against your naughty spending side
act as a physical barrier against impulsive spending 💸
You can lower the limit to such a low level that it's an amount you can clear off 0️⃣ each month without any headaches. No matter how disciplined you think you are, trust me, there will be a time when you would want to 😈 just make that one further purchase on your credit card when you dont have the cash for it at that moment. 🤪
Lowering the limit allows the card to just stop at the pre-set level, physically making it impossible to make that ill-disciplined purchase. But as mentioned above, you have to be mindful with your credit utilisation ratio (CUR). If you dropped your credit limit SO low for discipline purposes, your spending would get quite close to your credit limit each month. As a result, your CUR would be quite high each month. This would damage your credit score in the long run.
For example, if the bank was happy to have your credit limit at £2500. Your average monthly spending is around £700. Your CUR would be around 28%. Well done👍, that's good CUR, leading to improving your credit score.
But if you dropped your credit limit to £1000 to protect against yourself, theoretically that's good discipline. But now, you have actually massively increased your CUR to 70%! 👎 (£700 spending divided by £1000 credit limit you have set)
I know 🤯, it's weird. Basically the lenders don't want you to borrow too much even though they are happy to give you more, i.e. high credit limit with CUR of around 30%. (They only want you to borrow on average around 30% of the total they are happy to lend you... WHAT?🤯)
Dropping your credit limit for 'good money discipline' resulting in high CUR is actually showing you are not good at handling debt. 🤪🤔 Clearing your bills to zero too frequently is also not ideal, as the banks don't like you doing so as that's lowering your average daily balance and hence they charge less interest from you. I AGREE! IT'S SO CONFUSING! 😵💫
Disadvantages of Lowering Your Credit Limit
- Increased Credit Utilization: Lowering your credit limit can increase your credit utilization ratio⚖️, which is the amount of credit you're using compared to your total available credit. A high credit utilization ratio can negatively impact your credit score. This will have long term impact on your financial health.
- Reduced Purchasing Power: A lower limit means you have less available credit to make purchases. This can be inconvenient, especially for unexpected expenses. In good money habits, I don't anticipate credit is ever my way of coping with unexpected events as I have my emergency fund for that, (but when you know what you're doing, running emergencies through your credit card which you clear with the emergency fund is a good way to earn perks 🤫)
- Difficulty Obtaining Future Credit: Lenders often consider your credit limit when evaluating your creditworthiness. A lower limit can make it harder to obtain new credit, such as loans or additional credit cards.
- Potential Negative Impact on Credit Score: While the impact on your credit score can vary, a sudden decrease in your credit limit can sometimes be seen as a negative sign by credit bureaus.
If you're considering lowering your credit limit, it's important to weigh the potential benefits against these drawbacks. If you're struggling with debt, there might be other strategies, such as creating a budget or seeking debt counseling, that can be more effective than just simply lowering your credit limit.
I am writing another post about my idiotic journey 😶🌫️ with credit cards. My bumpy ride with credit cards is a perfect demonstration of what not to do.
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