Ka-ching! Getting a letter in the mail that says your line of credit has been increased can feel like a golden ticket. Pat yourself on the back for keeping a good enough credit history to qualify for a credit limit increase, but don’t rush out to spend that extra credit.
Being offered a credit limit increase can be an indicator that your financials are improving. It also gives you greater financial flexibility, and it can improve your credit score. But a higher credit limit has its downsides, the most common of which is the temptation to fall into more debt.
Before you take advantage of your new line of credit, here are some things you need to know.
- Banks are not doing you a favor by increasing your credit.
When a bank increases your credit limit because you’ve been a good customer who has always paid on time, it can feel like they’re doing something generous for you. However, their motivations are never selfless. Ultimately, they’re extending you a bigger line of credit because they think that they can profit off of it.
Sometimes credit card companies increase your credit limit for retention; they want to make sure you don’t cancel the card in favor of another that offers you more credit. Sometimes they do it in order to get you to use their credit card over another you may have in your wallet. Often times, credit card companies increase your credit limit in order to encourage you to carry a balance and thus pay interest fees.
Whatever the reason, they all boil down to one thing: the bank thinks that giving you more credit will give them more profit. Plain and simple.
- Automatic credit limit increases are better for your credit score than requested ones.
As you may already know, having your credit report pulled, like when you apply for a new credit card, can lower your credit score temporarily. If it happens once a year, it’s no big deal. But if you have what are called “hard pulls” on your credit once a month, this can add up to an overall decrease in your score.
If your credit limit is increased automatically, this rarely results in a hard pull. An automatic increase is often based on your relationship with your current lender and not your credit history. When you applied for the credit card, the bank wasn’t sure whether or not you’d pose a big risk as a borrower. However, after a year of using your credit card, they’ve been able to analyze your spending habits and now see that you’re a good person to lend to.
However, if you request a credit limit increase, this can result in a hard pull. It all depends on your bank. Some credit card companies do a hard pull when you request a bigger line of credit, and some don’t.
- Don’t reject that credit limit increase!’
The biggest way in which a credit limit increase affects your credit score is through your credit utilization ratio. This is your debt to credit ratio, and it’s one of the most important factors in your credit history. The more credit and less debt you have, the lower the ratio, and the higher your credit score.
For example, having access to $10,000 in credit and having $1,500 in debt is actually better for your credit score than having access to $2,000 in credit and having $1,000 in debt.
This is why both opening a new credit card and receiving a credit limit increase can favorably impact your credit score quite a bit. Both increase your total available credit and thereby decreasing your credit utilization ratio. However, this only stands if you don’t spend any more than you have been. If you receive a credit limit increase and then increase your debt accordingly, your credit utilization ratio will stay the same, and your credit score likely will too.
- Don’t increase your spending.
Don’t rush out to spend your newfound credit. Many times, credit limit increases are designed to get you to fork over more of your money to the banks in the form of interest fees. If you use your new line of credit as an excuse to spend more, this is exactly what will happen.
The more credit you have access to, the easier it is to fall into the trap of carrying a balance, especially if you’re not used to having a bigger credit limit. The best option for anyone who is tempted to spend more than they make is to simply appreciate that your new line of credit might give your credit score a little bump and then go on pretending as if your credit limit had never been increased.
- Continue paying your card off in full each month.
There are some situations in which it might make sense to take advantage of an increased credit limit. There are a number of purchases that you should put on their credit cards.
For example, perhaps you’re enjoying a 0% promotional APR on balance transfers or purchases for the first year of the card. If your credit limit is increased, you could take advantage of that 0% APR to transfer additional debt or to make any bigger, necessary purchases you have coming up in the near future.
Maybe your credit card offers rewards. In this case, it makes sense to put more of your regular monthly expenses, or perhaps even some of your bills on the credit card will help you rack up points and cash back more quickly. If you have a lot of business expenses that you’re reimbursed for, you could also use your new credit limit increase to cover those.
Even when it’s advantageous to increase your spending and use that new credit limit, the most important thing is that you only put purchases on the card if you’re sure you can pay them off at the end of the month.
- Take out a loan if you find yourself in a financial emergency.
If you do find that you’re really in need of extra money due to an unexpected expense or emergency, using your new line of credit should be your last resort. Unless you’re taking advantage of a 0% promotional APR, interest rates on revolving credit are usually sky high.
Instead, consider using the good relationship you’ve built with your lender to apply for a personal loan. These often have far lower interest rates than credit cards and can even improve your credit score.