All credit cards have some sort of a credit limit, which is the maximum amount that you can charge to the respective account before any charges are void. However, this credit limit isn’t information that consumers are typically privy to – unless they apply for the card, that is. That’s largely because before a creditor can issue any sort of a limit, it has to know your credit score as well as other crucial information, like how much money you make, your monthly debt obligations, credit report history and more.

The Rule of Thumb

Just because you won’t get the specifics of your credit limit until you’ve gone through the application process – and become approved – doesn’t mean that you can’t have a general idea of what it’s likely to be. Generally speaking, your credit limit is about double your monthly income, minus any debt obligations you have. So, for instance, if you make $5,000 a month and have debt obligations of $2,000 per month, your credit limit is likely to be in the $6,000 range. While this is the general rule of thumb, the key word is “general,” as there’s no true universal method and each creditor typically uses their own respective formulas.

Anatomy of the Credit Limit

There’s typically a lot that goes into the credit limit that creditors issue when you apply for a credit card. Here’s a brief overview of what helps make up this limit, aside from your monthly income and debts owed:

  • Credit score: The better your credit score, the less interest you’re likely to pay on purchases. You’re also more likely to have a higher credit limit, as a good credit score shows that you’re a reliable, responsible consumer that can adequately repay any credit card debt. Data shows, for example, that consumers with a FICO score of 720 or greater had an average credit limit of at least $8,000. Conversely, those with FICO scores at or below 620 had a significantly lower limit at an average of $700. So if you want a high limit and your credit score is sub-par, we’d recommend enacting some credit repair best practices prior to applying.
  • Payability: Credit limit is also largely contingent on a consumer’s ability to pay. Noting this, things like debt-to-income ratio, debt-to-asset ratio and consumer income after any debt is paid are all major factors that play into credit card limit.
  • Risk: This factor isn’t so much pertaining to your potential risk as a consumer, but any economic risk based on what’s going on in the world. For instance, during the Great Recession, credit cards were issued with much lower limits than what was issued before and after the economic downturn. Creditors often don’t want to chance a situation where you’ll max out your limit and be unable to repay debt.

It’s also important to note that the credit limit you initially receive should be thought of as more of a starting point. If a creditor sees that you’ve been responsible with your card, you’ll often see your limit increase over time. If the creditor doesn’t do this for you, you can even put in a limit increase request.

What to Expect When You Max-Out Your Credit Card?
According to the Federal Reserve, the average household credit card debt is at approximately $16,000. Maxed our credit cards are an epidemic. With this much debt it isn’t surprising that many people are in danger of maxing out their credit cards. It’s a good idea to stay well below the limits imposed on a credit card. This leaves a little wiggle room if an unexpected emergency would come up. If you would happen to exceed the credit limit on your card, the following is what you could expect to happen.

Inability to Use the Card

The first and most obvious consequence of maxing out a credit card is that there isn’t any credit left to use if it’s really needed. At the very least, a person would need to pay a minimum balance in order to be able to use the card again. Once the limit has been passed, however, simply bringing the balance back down may be the least of the card holder’s worries.

A Drop in Your Credit Score

Maxing out a card can cause your credit score to drop. How much available credit an individual has is a big factor in determining a credit score. This is called a high credit utilization ratio. The utilization ratio is determined by the amount of credit that is available on your cards to the amount that you’re using. It’s always ideal to have a utilization number that is as low as possible. Whenever you attempt to take out a mortgage or apply for any other type of loan, the fact that you maxed out your credit card will appear on your credit report.

The Possibility of a Penalty

Going beyond your credit limit may cause the company to charge an over-the-limit fee. Simply carrying a high balance could cause you to be pushed over the limit with finances charges. APR (annual percentage rate) is the percentage of interest charged on the amount that’s owed on the card. Your interest rate or penalties may be charged at the highest APR a credit card company can legally charge. That rate is currently 29.99 percent.

The Account May Be Closed

Credit card companies can close an account for many reasons and sometimes choose to do so if the limit has been passed. If your account has been closed it is advised to call the company as soon as possible. If they verify that the account has been closed because you’ve passed your limit you should make a payment as quickly as possible. If you’re able to make a payment so you’re no longer over the limit they may reinstate your card.

If you’ve gone over your credit limit, have incurred penalties, or even had a credit card account closed, there are things you can do to help fix your credit. Feel free to call our office at 617-265-7900 or schedule a free consultation.

Choosing your next credit card

When you are first rebuilding your credit, it can be tempting to jump at any card that will have you. But, after you’ve developed some positive credit history, you can afford to be choosier when it comes to credit card offers. Before you apply for that new piece of plastic, give some thought to all of the following regarding Choosing a new credit card.

1. The APR

The annual percentage rate is how much it will cost you in interest to carry a balance on the card. In many cases, it is a certain set percentage plus prime, which is variable. Try to get the lowest APR you can qualify for, even if you don’t plan to carry a balance on the account. If you are not approved for a low rate at first, you can also call back periodically and ask for a lower rate.

2. The credit limit

With a card that only has a limit of a thousand or so dollars, it’s easy to hit a high utilization rate quickly. This can drag down your credit score. Be careful about limits and try to keep your balance under 30% of what is available. If you feel you can safely manage more credit, ask your credit card company for a higher limit. They’ll have to run your credit again, but, they may extend a higher rate if you have a good history of payment.

3. Annual fees

This is where many cards, especially reward cards, get you. Some cards have fees as high as $100 per year. When possible, look for cards that carry no annual fees. If you are looking at a rewards card that has a sizable fee, do the math to figure out whether the incentives are enough to balance the annual cost. You should also know what fees are charged if you forget to make a payment or if you go over your limit.

4. Rewards and incentives

It’s fun to get paid to spend your own money. Look for cards that offer cash back or bonuses. Ideally, these cards should offer bonuses in categories that you use often and come with no fees. If your card is one that offers different cash back bonuses at different times of year, time your spending to make the most out of your new card. When looking at incentives, you should also assess the requirements. To get some bonuses, you have to put a certain amount of charges on the card within a set period of time.

5. Your spending habits

Look at past credit card bills and your monthly bank records to honestly assess how you spend money. Do you tend to overspend when you have access to new credit? And, do you have a good reason for applying for a new card? If you do not have a lot of financial discipline, it may be best to think twice about getting a new card if there’s not much benefit.

Credit can be a temptation, but, it can also be a handy tool. Access to credit cards can mean more control over when you and how you spend and can give you bonuses like cash back and airline miles. Need some help learning to manage credit wisely? Get in touch with us. At Key Credit Repair, we offer counseling and advice to help you make the most of your financial life.