Occasionally we get questions from readers who have gotten an automatic credit limit increase, and they wonder if there is a downside to accepting it. Or they close a little-used account and their credit scores go down, even though they are using cards and paying them off exactly as they had been.
What’s going on here? Credit scores are calculated in part based on how much of your available credit is being used. You can calculate your overall utilization by adding up all the reported balances on your revolving accounts (i.e. credit cards, lines of credit) and dividing that figure by the total credit limits. Credit scores also weigh in each individual account’s utilization rate.
Your amount of debt, which includes your “debt usage,” (or “utilization”) as it’s called, accounts for roughly 30% of your credit scores. That’s more than any other single factor except paying on time, which accounts for about 35% of your score. Getting a higher credit limit can be a good thing — assuming you don’t increase your debt in tandem — because it results in a lower debt utilization.
In general, the lower your balances relative to credit limit, the better. Credit experts suggest keeping this ratio at 25% or less, but if you are trying to improve your score, you may want to aim for no more than 10%. (You do want to use at least one of your credit cards, though. Having no activity at all doesn’t offer much insight into your repayment habits, and unused cards are at risk of being canceled, which would reduce your available credit and lower your credit age, another major scoring factor.) Using a credit card payoff calculator like this one can help you determine how long it will take you to get out of debt.
If you are concerned that you might be using more than the optimal amount of credit, you can set up mobile alerts to let you know when you are nearing a set spending amount. You can also pay early (or multiple times per month) to keep the balance low. This can be particularly smart if you are rebuilding credit with a secured credit card and have a low limit. You may also want to consider getting another credit card to lower your overall debt utilization rate — you can shop for credit cards on Credit.com.
So is there any reason to even hesitate at the idea of a higher credit limit? There might be, if a higher limit will tempt you to spend more than you need to (or spend currently). A little self-knowledge can tell you if this is a danger.
Another time you may want to choose a lower credit limit is if you add an authorized user to your card. Adding someone to your account gives them access to your entire credit line. If you intend to give your child, or a significant other, access to your card, it might be wise to limit the damage that can be done if he or she doesn’t handle it as responsibly as you hoped. (You can also set up credit alerts to let you know when the card is used.)
Finally, if you co-sign a card application, be aware that this card will affect your credit as if it were your own. That means the credit limit, any late payments, etc., could affect your score. And, unless the terms and agreements say otherwise, the credit limit can be changed without your knowledge or approval if the primary borrower is at least 21 years old.
It’s one more reason to keep tabs on your credit scores. Credit.com’s free credit report summary can help you see how your debt usage is affecting your scores, how much of your available credit you’re using and how your debt usage compares to your peers.
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