Credit cards are useful tools to make large purchases, build your credit history, and earn rewards from your spending. Even if you don’t like credit cards, the credit history you develop from using them helps secure you better terms when you need large loans like a mortgage or auto loan.
To use your credit responsibly, you should spend within your credit limit, avoid credit card debt, and make on-time payments. Banks and credit card companies reward responsible users through credit limit increases. There are benefits to a credit limit increase, whether you request it or it’s automatic. But there are also cons that affect your spending habits and your credit report.
- Credit card companies give limit increases if you progress on a built-in path to retain customers or to promote overspending to make more on interest fees.
- The card industry makes 50% of its income from interest and penalties, meaning overspending consumers drive their bottom line.
- The disadvantages of increasing credit limit include overspending, identity theft risk, and difficulty getting loans in the future.
- The pros of one include a better credit score and peace of mind from more spending power.
Why Did I Get a Credit Limit Increase?
You can either apply for a credit limit increase or request one from your issuing bank. Every issuer has its own way to decide if a cardholder should get an increase. Here are some of the factors they consider:
Your credit card may offer a preset path to a higher limit if you met the criteria laid out in your card agreement or application. Like other financial products, the fine details of how they work outline the features and benefits of each card.
For several years, the credit card market has been filled with dozens of rewards cards. Cardholders are bombarded with great offers almost daily to take on new cards, ranging from zero-fee balance transfers and sign-up bonuses. If a credit card issuer wants to retain a customer, then granting a credit line increase is a great way to do it.
I’ve used Chase cards for several years and have been awarded limit increases for paying on time and continually using their cards.
Make More from Interest Charges
Credit issuers may grant an increase to incentivize users to spend more and develop credit card debt. But how much do card companies make from this?
The Real Credit Card Industry Business Model
A 2020 credit card industry analysis by the Motley Fool, had revealing insights into how much credit card issuers make. Key highlights include:
- Card issuers made $176 billion in 2020
- 43% of their income ($76 billion) came from the interest cardholders paid on their outstanding balances
- 50% of their income ($88 billion) came from interest and penalty charges
A credit card company profits off of customers with bad financial habits. If you have debt on cards with high APRs, the interest will compound over time — creating a debt trap.
A good customer is not a profitable one. Healthy credit habits save you money that could go to your card issuer.
Factors Behind Your Credit Score
Your credit score is an overall measure of how trustworthy you are with handling credit and debt. Creditors such as banks and lenders periodically report your credit and debt activities to the three bureaus – Experian, TransUnion, and Equifax. Each bureau couples your recent activity with your history to calculate your score. Two of the factors behind your score are about to credit limit increases.
Payment History – 35%
Making up the largest weight, your record of on-time payments is the biggest factor in your score and the best predictor of your creditworthiness.
Credit card issuers report your payments twice a month. If you miss a payment, it can stay on your record for up to 7 years. A few missed payments can set your score back, but it’s easy to recover if you pay back your bills on time and use auto-pay.
Balance Owed – 30%
Your credit utilization ratio is a measure of your outstanding balance across all credit lines against your total credit limit. It measures how much of your available credit you use. You can use the same method to calculate your per card utilization.
Balance Owed indicates how much credit a person uses to finance their lifestyle and its trend makes up a key part of your credit history. Scoring methods use individual ratios based on the account type, e.g. credit card, auto loan, mortgage.
If you use less than 30% of your total credit line, you are in good standing with creditors. Bonus points if you can get your aggregate utilization below 15% or 10%. A lower credit utilisation ratio is always better.
Disadvantages of Increasing Credit Limit
When you earn a credit limit increase, it can negatively affect your credit score and your spending habits. Here are some potential disadvantages:
1) Temptation to Overspend
A higher credit limit means you have more money to play with, which can tempt you to overspend. People often spend beyond their means, build up interest, and fall into a spiral of compounding interest fees and late payments. Applying for a new credit card does the same thing.
To avoid this debt trap, it helps to adopt a long-term mindset with your finances and use tools like a budget to track your spending.
2) Credit Score May Fall
When your credit card limit increases, you see a boost in your credit score. But if you spend more, you will offset the effects of that boost. The more you use of your credit limit, the higher your credit utilization ratio will be leading to a decline in your credit score.
3) Hard Inquiry on Credit Report
There are two types of credit inquiries — soft and hard. If you request a credit increase, your bank may perform a hard pull of your credit report. Hard pulls hurt your credit score and stay on record for two years. A bank will request your permission before doing any credit inquiries.
It’s best to not have too many hard inquiries in a short period of time as it will bring down your score and make future creditors suspect as to why you need so much credit. In contrast, a soft inquiry does not affect your score or credit report.
4) Difficulty To Get a Loan
If you recently had a limit increase, it can be harder to get a mortgage or other loan. A bank may feel you are not the best at managing your finances as you need access to more credit.
Moreover, it’s more of an issue if you already have a high credit utilization ratio. Other factors such as having too many hard inquiries or new lines of credit can also count against you. As a result, a banker can ask clarifying questions while evaluating your application or offer you worse loan terms with a higher interest rate.
5) Higher Risk of Identity Theft
When your credit limits go up, credit bureaus will share your updated info with data brokers and marketers who will send you credit card or loan offers. Your data becomes more accessible and hackers could use it to commit fraud. A high credit limit and a good score garner more interest from thieves.
Advantages of Increasing Credit Limit
A higher credit limit will help both your credit score and financial situation.
1) Better Credit Score
Depending on your spending, a credit limit increase reduces your utilization ratio. Thus, your Balanced Owed decreases, and your credit score goes up sometimes by a considerable amount.
2) More Spending Power
A bigger credit limit brings more spending power. Even if you maintain spending levels, you can put more purchases on your cards to boost your reward points. Applying for a new credit card can provide the same benefits.
3) Peace of Mind
More spending power equals more peace of mind. A better spending limit can be reassuring as you have more resources to tap when needed. Recently, my friend had to undergo an operation. He had an individual card and charged his medical bills to it. He incurred a very high credit utilization ratio as his Balance Owed soared. Even though he had a good credit history and paid off his bills, his low credit limit reduced his score.
We recommend building an emergency fund to tap when necessary to quickly payoff your bills.
The Bottom Line
Overall, the disadvantages of increasing credit limit impact those who overspend or who anticipate taking out debt in the future. The advantages win out as a higher limit comes with extra credit and a better score that you can leverage to get better deals on future loans. Overall, credit is a net positive in responsible hands but the disadvantages of increasing credit limit trump less the benefits in less responsible hands.