What is credit limit?
Credit cards come with a credit limit; This limit varies from one card type to another and is dependent on various factors. The income of the applicant is one of the main factors that determine the credit limit while applying for the card, apart from many other factors. Credit limit is the maximum amount that a card user can spend on the card issued.
Thus if a card has a limit of Rs. 100,000 then the user can spend up to that amount in the billing cycle. Once the dues are repaid the limit is again set at Rs. 100,000 for the next billing cycle. The CIBIL report mentions the details of all your active cards along with their limits.
Effect of Credit Limit on Credit Score:
Let us now explore the effect of credit limit on credit rating, if any. As we discussed above, credit utilization is one of the five factors that affect credit score. Credit utilization, in turn, is affected by the credit card limit and card usage.
Credit Utilization = Card Usage / Credit Limit
It is calculated for each card as well as all cards put together. Thus if a credit card with a limit of Rs. 100,000 and the average billing on that card is Rs. 35,000 then the utilization of that card is 35%. If there is another card with 150,000 and the average usage of that card is also Rs. 35,000 the utilization ratio for that card is 23.33% and the utilization ratio for both the cards together is 28%.
Thus the credit utilization of all the cards individually and collectively is taken into account when the score is being calculated. High credit utilization ratio is not good for credit rating. So if one has a consistently high credit card utilization (more than 30% of the sanctioned limit), they should consider getting a higher card limit sanctioned.
Getting the bigger range will help the user to deal with the higher utility ratio; A consistently high credit utilization ratio can result in a low CIBIL score. This factor is the biggest contributor to the credit score after repayment history.
However remember that a higher limit for your credit card will only help if you are able to pay your credit card dues on time and keep a check on your spending. A high limit is not an excuse to spend more, as it will defeat the purpose of raising it and can lead to bigger problems if you fail to pay the dues on time.
Why is high loan utilization a problem?
One may wonder why high utilization is a problem if he/she can pay his/her credit card dues on time and spends are within the sanctioned limit? This is a problem because it reveals credit hungry behavior on the part of the card user. It also indicates a high risk profile for the card user, both of which are not good signs for credit health.