Should I increase my credit limit? Know the risks and benefits

Your credit limit is how much you can spend on your credit card each month. If you regularly use your credit card, getting a higher credit limit ensures you stay within your available credit. After all, you don't want to be worried about maxing out your credit card when you're out and about.

But are credit limit increases a good idea? With the right credit management skills, getting more credit can improve your credit score and give you more spending room for everyday purchases. Before getting a higher credit limit, it's essential to think about the risks and benefits to ensure you can handle more credit responsibly.

Read on to understand a credit limit, how financial institutions increase your limit, and what you should consider before getting one.

What is a credit limit?

A credit card is a credit account with revolving credit and a credit limit. A credit limit is the maximum amount a lender will give you to spend on your credit account. You can have a limit for lines of credit and credit cards. The purpose of credit limits is to limit the risk of lending you money. If you go over your credit limit, the credit card company can charge fees. Lenders can increase or decrease your credit limit as they see fit. They may automatically approve a credit limit increase if you have a high credit score, have a low credit utilization, and regularly pay your credit card balance on time.

Credit companies determine your credit limit based on several factors. For example, the application form requests your current income and employment information to assess your financial stability. Individuals with high incomes may get a higher credit limit because they have better stability and are less likely to default on loans.

You're also more likely to get approved for a credit limit increase if you have a higher credit score. Your credit score assesses your overall financial health, considering factors like credit accounts, payment and credit history, and credit utilization rate. Since lenders take on a certain level of risk when they approve you for a credit card and a credit limit increase, a higher credit score proves you're financially responsible, and they can trust you with larger credit accounts.

What are the benefits of increasing your credit card limit?

There are many benefits to asking for a credit limit increase. A higher credit limit can often work in your favour to increase your credit score and give you access to more benefits for loans and interest rates. Here are a few benefits of increasing your available credit limit.

A bigger cushion for emergencies

Most people use their credit cards for everyday purchases like gas, groceries, and dining out. While your emergency fund gives you a safety net during financial emergencies to prevent you from falling into debt, a credit card can give you extra piece of mind. It may not be a good idea to put large purchases on your credit card in emergencies, especially if you aren't confident about paying off the balance. However, you can rely on your higher credit card limit if you have no other options.

Reduces your credit utilization ratio

Your credit card utilization ratio is the percentage of your total credit limit you use. If your credit limit is $1,000 and your credit card balance is $500, your credit utilization rate is 50%. Experts recommend having a credit utilization rate of 30% or lower each month. A high credit utilization means you spend a lot of money on credit, which can indicate larger financial issues.

Getting a higher credit limit increases gives you more spending room. If you responsibly manage your credit limit, like paying off balances right away or not spending too much, your credit utilization will be lower, and your credit score can increase. If your limit is $2,000, $500 is only 25% of your available credit.

Increases your spending power

An increased credit limit unlocks greater purchasing power. You have more room for big-ticket items, like a vacation package, furniture, recurring bills, and electronics. However, with more spending power comes greater responsibility to use your higher credit limit responsibly. Ensure you have enough money to pay off your credit card balance on time each month. Late or missed payments can decrease your credit score.

Helps you maximize rewards

Many credit cards offer rewards for spending money. With a higher limit, you have more purchasing power and thus can potentially spend more money and earn more rewards. Credit card rewards can help you save money on everyday purchases and allow you to redeem points on travel and merchandise. Some credit card companies offer bonus perks like insurance coverage, roadside assistance, discounts at your favourite retailers, and extended warranties.

Drawbacks of a credit limit increase

While there are several benefits of accepting a credit limit increase, there are also a few drawbacks.

Risk of overspending

It's easy to think your credit limit is how much money you should spend each month. While there's always a risk of overspending and going over your credit limit, the consequences are more serious when you have a higher limit. Let's say your limit increases from $1,000 to $2,000. You may have the money to pay off $1,000 if you max out your credit card, but you may not have the money to pay off $2,000. Overspending or living beyond your means is a big concern when requesting a credit card limit increase, as it can quickly turn into irresponsible spending.

Impacts your credit mix

The number and types of credit accounts you have can impact your credit score. Credit bureaus and financial institutions like to see a variety of credit accounts. If you only have credit cards, you may not be optimizing and diversifying your credit mix enough. Consider alternative loans, like personal loans and lines of credit, for extra spending room before requesting a credit limit increase. Alternative credit lines can also be helpful if you tend to carry a credit card balance, as interest charges are expensive.

How to increase your credit limit

To increase your credit limit, you typically have to make a request with the credit card issuer. Credit limit increase requests get approved on a case-by-case basis by the issuer. They look at your credit report, income, account history, current open accounts, and other information to determine your eligibility. There are two ways you can typically get a credit limit increase for your credit card account.

Automatic credit card increase

The credit card company may offer you a credit limit increase if you've shown good financial behaviour for an extended period. For example, they may proactively give you additional credit if you consistently maintain a lower credit utilization ratio and pay your credit statement on time. You can choose to accept or decline the offer.

Apply for a credit limit increase

If you don't have an automatic increase, you can always apply for an increase by going to a branch or submitting an application through the online portal or mobile application. You can choose how much credit you want. The card issuer will look at your credit score and income, as well as your account information and payment history, when deciding to approve the increase.

Difference between soft and hard inquiry

When you apply for a new credit account or financial product, you may be subject to a soft or hard credit inquiry. You can also conduct a soft inquiry by getting your free credit score to monitor your report and ensure you stay on the right track. Some employers may also conduct a soft credit check as part of your employment inquiry.

Soft credit inquiry

A soft credit check is an inquiry into your credit report. You can initiate one for yourself, or a third party can initiate one to get your credit report information. A soft inquiry can happen even if you didn't request one, as financial institutions use them to screen you for preapproval offers and products. You can get a soft credit report from a credit bureau or see if your credit card issuer offers free credit reports. A soft credit inquiry typically doesn't impact your credit score.

Hard credit inquiry

A hard credit check typically happens when a lender or financial institution reviews your information when you apply for new credit, such as a mortgage, a credit card, or a personal loan. Potential lenders do a hard check to assess your financial health and determine how much risk you pose as a borrower. The credit card issuer may provide a hard inquiry when you ask for a credit limit increase. Hard inquiries can impact your credit score, and too many hard credit checks within a short period can be a red flag.

How can a credit limit increase hurt your credit score?

The impact of increasing your credit limit on your credit score depends on whether you get a hard or soft inquiry. A credit limit increase typically results in a hard credit check, which can impact your credit score. When you submit a credit limit increase request, the issuer pulls your credit report to verify your credit score, payment history, and credit information. They're assessing your eligibility for a credit increase as lending more money to you involves more risk. If you didn't request a credit limit increase and the credit card issuer automatically preapproved you for one, you may only have a soft inquiry, which won't impact your credit score.

How to increase your credit limit without hurting your score

As long as you pay your credit statement on time and are responsible for how you use your credit score, a credit limit increase typically doesn't hurt your credit score in the long run. If you open several new credit card accounts, especially within a short period, your credit score may drop. It may impact your score temporarily, but your credit score can change monthly, so don't worry too much about your good credit.

Building your credit with KOHO

Building your credit with KOHO is easy when you have access to your credit report and a variety of products to create a strong portfolio. If you want to spend money instantly wherever you are without reaching for your wallet, a virtual credit card is the way to go. You earn cash back for every dollar spent and can manage your money to ensure you spend responsibly.

Cover is a subscription-based overdraft protection coverage to help you avoid expensive overdraft fees and interest charges when you go over your credit limit. As long as you pay the subscription fee and make on-time payments, there are no interest charges or additional fees.

Learn more about how you can earn interest, build good credit, and keep your finances in check with KOHO.