What is a credit limit and does it matter?

What is a credit limit?

A ‘credit limit’ is the maximum amount of money a lender will loan to you via one of their credit products. The term is widely used across the financial product market and can apply to all different kinds of loans, such as home, car, personal or margin loans and credit cards.

What is a credit limit on credit cards?

When you take out a credit card, you are signing up for a loan from a financial institution. You’re also agreeing that you will pay back that loan under certain conditions. Generally, credit cards are set up so that you can continually borrow portions of the loaned amount and pay them back according to a schedule. You are charged interest depending on that repayment schedule.

The credit limit is the amount of loaned money you and the lender agree you can access on that card. But it’s important to know that this doesn’t mean that the card will stop working automatically when the credit limit is reached. That depends on the loan agreement that you have with the financial institution.

Explore: How to get a credit card: Are you eligible?

How does a credit limit on a credit card work?

A financial institution may offer credit card products with different credit limits, such as $2,000, $10,000 or even $50,000.

Let’s say someone chose a card with a $10,000 credit limit. This means that the total amount of money that person can borrow using that credit card would be $10,000 in total.

That person would apply for the credit card and the financial institution would evaluate their application and decide whether or not to issue the card; considering factors such as their credit score. If the application was successful, that person would receive the credit card (or a virtual version of it) and be able to use it to borrow up to $10,000 for purchases.

If a borrower has spent all available funds on the credit card and has a $0 balance. continuing to make any further transactions – and exceeding the credit limit – would depend on the particular policy taken out with a lender, and the terms and conditions that apply to the agreed credit contract.

For many borrowers, they can track their credit card spending via their bank’s mobile phone app. Fees and charges would also apply, based on the credit card terms and conditions, and be reflected in the statement progressively.

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Can you go over your credit card credit limit?

Whether or not you can spend more than your limit on your credit card depends on the agreement you have with your financial institution. It’s a wise idea to find out what the financial institution’s rules are for ‘over-the-limit’ spending before signing up.

Some agreements do automatically prevent transactions being made once the credit limit has been reached. In this case, purchases could be declined once a user has spent up to their allowable limit.

Some financial institutions allow credit card holders to ask that they not be allowed to exceed their credit limit, to help them to control their debt levels. Other financial institutions will only allow certain eligible cardholders to exceed their limit, such as those with a strong credit history.

If you do spend over your credit limit, you may be charged a fee or have to pay extra interest, but this comes down to your policy.

Not all banks charge ‘over-the-limit’ (also called overlimit) fees. But any purchase made via a credit card is added to the balance of the card, which means you still have to pay it back within a certain amount of time, typically with interest.

Even if you don’t plan on spending more than your credit card limit, fees and charges could lead to your account becoming overdrawn. Your personal credit score may be negatively affected if you don’t make regular repayments on your credit card.

Explore: How to find the best credit card for first timers

Can you change your credit limit?

Generally, you can request to raise or lower your credit limit via online banking, over the phone or at a branch, depending on your lender. When requesting to raise your limit, your lender is under no obligation to approve your application, and will typically ask you to provide information about your current financial situation. This information may include your income, credit score, assets, expenses and other debts such as other credit cards or loans. This ensures that the new proposed credit limit suits your needs.

Does increasing your credit limit hurt your credit score?

Increasing your credit limit can have an impact on your credit score, especially if you have a large limit already. If you request an increase, your lender may do a credit check, which would appear on your credit report as an enquiry. If you make multiple credit enquiries in a short period of time it could lower your credit score. This is due to financial institutions making the assumption that you’re in desperate need of credit and that you may not be in a stable financial position. It’s wise to check your credit score before you apply to increase your limit.

Why does your credit limit matter?

Credit limits are important because they can determine:

1.  How much you can spend. Credit limits determine how much money you will have at your disposal to make purchases. Compared to other types of loans, credit cards are typically more flexible in terms of when you can spend the funds and what you can spend it on. For example, credit cards typically allow you to borrow a succession of small or larger sums, and use them to buy whatever you need (providing the seller accepts the type of credit card that you have). Whereas if you take out a car loan, for example, you have to use the loan for purchasing a vehicle.

Keep in mind, though, that money borrowed on a credit card has to be paid back under strict conditions, and typically attracts a higher interest rate for unpaid balances than some other forms of credit.

2. How much potential debt you want. The credit limit is the amount of money you can loan from the financial institution. You will be able to borrow up to that amount and pay it back in instalments, with interest applying if payments aren’t made in a specified time frame. If you want to try and minimise your debt levels, opting for a lower credit limit may help you to control your spending.

Keep in mind that fees and charges, including interest, usually apply when using a credit card, and these can accumulate over time. Developing a budget and learning how to manage expenses effectively can be helpful in minimising overall debt, and you could even consider saving up and creating an emergency fund, instead of relying on credit.

Learn more: Pros & cons of using a credit card

3. Your credit rating. How much you have borrowed or have applied to borrow, will be listed on your credit report. Financial institutions and other parties may check this report which includes information about your credit cards, and what limits those cards have in total. The total credit limit, regardless of how much of that credit you have used, will be considered when calculating your credit score. For example, you could have multiple credit cards with different banks. Your debt level will be calculated by adding up the limits of all of your credit cards. Your repayment history is considered too. Why does this matter? Banks will check your credit score whenever you apply to borrow money, and your score could impact other applications, such as for rental properties. You can check your credit score for free with Canstar or via the Canstar app.

If you are considering a credit card, it’s important to read policy documents, such as the Target Market Determination and Key Facts Sheet, to support your decision making.

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