Credit limit is the first thing banks or financial institutions reveal about a credit card. Even when we plan to apply for one, we shop for it based on its limit. The terms credit limit or credit card limit are hence not alien to most of the credit card users.
As a refresher, credit limit is the maximum amount one can spend on a credit card. Typically set by issuing banks/financial institutions, credit limit is not same for every credit card. Just like how credit cards come in various shapes and sizes (features and benefits) so does credit limit.
Even before knowing about how much credit limit of your card can be used, let’s look at some of the basics about credit limit.
How do banks decide credit limit?
The exact method of credit limit calculation is not known as it is bank specific. Hence, it often becomes difficult to predict your credit limit. However, there are a few known things that banks usually consider to determine your credit limit. Your monthly income, fixed expenses, and financial obligations.
Banks look at various documents such as salary slips, tax documents, bank statements, and credit report to get a clear picture of your financial situation.
Once they have everything in hand, they typically multiply the gross monthly income by 2-3 times, deduct all the monthly obligations including basic monthly expenses, fixed monthly obligations such as EMIs for loans, if any, to determine the credit limit. The multiplier may vary depending on the applicant’s risk factor and bank’s credit policy.
Furthermore, the applicant’s debt-to-income ratio, which is calculated by dividing all the EMIs by monthly salary, will also be considered while deciding the credit limit.
Cash limit is part of the credit limit
While credit limit indicates the maximum spending limit on the card, cash limit tells you how much cash you can withdraw using your credit card.
Credit cards do offer a cash withdrawal feature which enables the user to withdraw a certain amount of cash.
One thing to consider here is that the cash limit is part of the total credit limit and should not be considered as an additional amount available on the card.
For instance, if your credit card limit is Rs.50,000 and cash limit is Rs.10,000, the total limit available on the card is still Rs.50,000 and not Rs.60,000. Simply put, the cash withdrawal limit is a part of credit limit, not an addition to it.
The consequences of using your credit limit to the fullest
Now coming back to the main point, how much credit limit can be used. This may sound invalid to many because the limit itself sets a cap on the credit card usage and putting a limit on it again makes no sense. However, experts always recommend not to use your credit limit to the fullest. They say that using the credit limit completely results in high credit utilisation ratio thereby denting your credit score. Let’s see how it happens.
● Credit score and credit utilisation ratio
You might be aware of the term ‘credit score’ which is a number calculated using your credit history and repayment behaviour. A higher score typically indicates you’re at less credit risk thus prompts lenders to approve your loans quickly and easily.
Well, talking about credit utilisation ratio, not many are aware of this and how it impacts their credit score. Simply put, credit utilisation ratio is the percentage of credit used from the total credit limit. The total credit limit includes credit limit on all the existing credit cards owned by an individual.
For instance, if you have three credit cards of different origin, each having a credit limit of Rs.10,000, and have spent Rs.2,000 on each card, your credit utilisation ratio will be calculated by taking the sum of the spending on all cards, divided by the credit limit on all cards. Here it is 8,000/3,0000*100, which gives you a credit utilisation ratio of 26.67%.
● Using maximum credit limit results in higher credit utilisation ratio
The credit utilisation ratio essentially indicates how much credit you have utilised from the total credit limit. While a low utilisation ratio indicates you’re less dependent on credit, a higher ratio indicates you’re highly dependent on it.
Your credit utilisation ratio will be higher only when you use your credit limit to the fullest. For instance, imagine on you have three credit cards with Rs.10,000 credit limit each, you have spent Rs.9,000 on each card, then your credit utilisation ratio becomes 27,000/30,000*100, which is equal to 90%. This means you’ve used 90% of your total credit limit.
Credit utilisation ratio can be calculated for a single card or multiple cards. When you consider only one card, higher credit utilisation ratio is a result of maxing out your credit limit. The closer you approach your credit limit the higher your credit utilisation ratio will be.
● High credit utilisation ratio = low credit score
The very first consequence of high credit utilisation ratio is a low credit score. The reason – credit utilisation ratio is an important factor considered to find the creditworthiness of the person and it impacts 30% of the credit score.
A low credit score, as mentioned earlier, indicates higher credit risk and impacts your loan eligibilites. Citing it as a reason, banks may sanction you a lesser loan amount, or loans with high interest rates, or sometimes reject your application if your score is too low. Irrespective of the consequence, having a low credit score is not healthy if you’re planning to take any big-ticket loans in the future such as a home loan.
How much of credit limit can be used?
Now that you are aware of the consequences of using your credit limit to the fullest, let’s see how much you can use to be on the safer side.
Experts recommend maintaining a credit utilisation ratio of 30%, which means you need to limit your credit card spending to 30% of the total credit limit. Whether you are using a single card or multiple cards, make sure your total expenses are not exceeding 30% of the total limit.
If you have a total credit limit of Rs.1 lakh, to achieve a good credit score, you should limit your credit card expenses to Rs.30,000 to Rs.35,000. Also, make sure to clear the outstanding dues on time.
If it seems a little difficult to cut your expenses, a pro-tip would be to increase your credit limit. Credit limit enhancement is, however, possible only when you have used the card for a minimum of six months and have a decent repayment history.
You can raise a request for credit limit enhancement by contacting your bank’s customer care helplines. Approving the request is completely at bank’s discretion.