How do credit limits work

Back to basics: How does a credit card work and do you REALLY need one?

How do credit limits work

Credit cards can be a useful tool if you follow the rules. They can help you to budget, improve your credit rating and spread the cost of borrowing over time.

But there are hundreds of cards out there to choose from and getting the wrong one could mean you get a raw deal.

Read this guide to help you decide whether you really need a credit card, how they work and what it could cost you to avoid any credit card nightmares.

Do you use your credit card a lot? Make sure you have chose one which suits your needs

Credit card will allow you to borrow and spend up to an agreed limit. You are then charged interest until the balance is cleared.

Your spending limit - or credit limit - will be decided by the provider and depend on your individual circumstances, taking into account factors such as income and credit history.

The interest you pay will be agreed before you sign for your credit card. Remember - it may not be the rate you see advertised as providers only have to offer this to 51 per cent of successful applicants.

Each month you will be sent an itemised bill of everything you have spent on the card. Most cards will come with period of a month or so after the bill being issued before any interest is charged. If you always clear your whole balance within this time, you won't pay any interest.

This interest-free grace period differs for each provider so check the terms and conditions. It could range from anywhere between 20 and 55 days.

Repayments will not go through instantly so make sure you leave enough time to avoid any interest.

Card providers will have a minimum repayment that they require each month - this is usually either a flat cash amount, or a percentage of the amount you owe, whichever is highest.

It is important to make sure you keep on top of this minimum repayment as failure to pay could trigger late payment or default notes on your credit file which can affect your ability to take out loans, mortgages and other products in the future.

Paying the minimum repayment requested by your card company won't actually contribute much to paying off your balance. It will clear any interest that has built but only reduce the overall debt by a tiny amount.

Clearing even a small debt would take years if you only paid the minimum amount so always try to clear as much as you can afford. You can see how this works with our Credit card reality check calculator. which can also be found at the bottom of the page.

How do credit limits work

Watch out: Credit cards can be a great tool but only if you follow the rules

One of the biggest benefits of a credit card is the consumer protection it provides you in case your purchase goes wrong.

If you have paid using your credit card the lender takes on the same liability as the retailer if you don't get what you've paid for, for whatever reason. Under the 1974 Consumer Credit Act, Section 75 any purchases you make worth between ?100 and ?30,000 are protected by your credit card provider.

So if you don't receive the goods, or they are faulty and need fixing, you will be able to claim the cost of repair or replacement from the company you bought it from and the card you bought it on.

Many people complain they have never applied for any credit - and therefore had no credit problems - yet have still been rejected.

Bizarrely, the credit industry feels more comfortable dealing with people who have a track record of paying off credit so you do actually have more chance of making a successful application if, for example, you have taken out a mortgage or loan previously.

This problem is easily solved. Take out a credit card, spend some money on it and pay it off each month. Lenders will now see that you can do this sensibly and will be more likely to lend you money.

Once you have decided whether you need a credit card or not, the next step is finding the right credit card suited to your needs.

There is a wide range to chose from that have attractive offers on cashback, transferring debt, spending, rewards and for helping you to build your credit rating.

With any card, it is important to discuss a realistic credit limit with your provider.

It might seem like free money but you will have to pay the balance off at some point, and your credit rating is at risk if you cannot pay off your bills on time.

Sarah Robb, credit cards expert at uSwitch says: 'As a golden rule, whatever card you have, set up a direct debit to make at least the minimum repayment every month.

Make sure you register to the right address - your credit history may be affected if you do not use the same billing address as the one where you are currently registered on the electoral roll.

Although some of the charges might not end up being relevant to you, you should always check out the full terms and conditions for any card you are considering.

Avoid cash withdrawals

Probably the biggest hidden cost is the charge for cash advances. Most often these refer to ATM withdrawals, but can also include paying money into other accounts, buying travellers cheques and even gambling and betting transactions.

In these cases you will have to stump up a handling fee averaging more than three per cent.

There will also be an individual interest rate charged on the amount of your cash advance, usually considerably more than the standard interest rate - around 25 per cent.

Remember, cash advance amounts usually have no zero-interest grace period, so to avoid hefty charges it's best to check what falls into that category and avoid them at all cost.

Withdrawing money abroad usually comes under a provider's cash advance rules, so with a standard card you can expect to fork out both the cash advance handling fee and the interest on top if you use an ATM.

Plus, standard cards will also charge you between two or three per cent charge for foreign currency exchange.

Stay within you limits

Most also carry a fee for spending beyond your credit limit, much like an unauthorised overdraft fee on a current account. There will also be late fees when you don't pay your bill on time. Providers usually charge a flat-rate ?12 for each of these transgressions.

There also tends to be a fee for returned payments, if you try to make a payment when you are beyond your credit limit. This averages at around ?11.

On top of all of these, there are flat-rate charges for requesting a one-off paper statement, which could cost up to ?6.


Does Spending More With a Credit Card Increase the Credit Score or Limit?

A good credit score means a better chance at a limit increase.

If you’re looking for an excuse to spend more using your credit card, you’ll need to do better than believing it will increase your credit score. Depending on how much more you spend, it could actually lower your score. And most credit card issuers don’t automatically raise your limit because you have embraced shopping full force. Although some credit card issuers might raise your credit limit after you’ve demonstrated you can pay your bills on time, you typically need to request an increase and be approved.

Five factors determine your credit score: your payment history, how much you owe, how long you’ve had credit, how much new credit you have been applying for and how diverse your credit is. The two biggest factors, which together account for 65 percent of your score, are payment history and amounts owed. To have a good credit score, you need to pay all your bills on time, and you should use only a percentage of your available credit.

If you start spending more of your available credit than you have been, your credit score is liable to decrease because it affects the “amounts owed” category of your credit report. If you have a $10,000 credit limit, for example, you should use no more than 30 percent of your available credit, or $3,000, to have the best chance of raising your credit score. Future lenders will be less willing to lend to you if it appears you max out your credit card or are close to doing so. That sends a message that you might be in debt over your head.

Credit card issuers don’t want to give away their secret recipe, so to speak, for determining your credit limit. Justine Rivero, credit advisor for Credit Karma, gives some insight into what the likely formula is: how much you earn and your credit score. By spending more and thus lowering your credit score, you will be doing the opposite of what it takes to get a higher limit. Credit Karma crunched the numbers and found that it’s better to have a good credit score and a lower income than a bad credit score and a high income. What you do with the money you have is the primary factor lenders look for when determining how much credit to grant.

The best way to get your limit raised on your credit card is to call or go online with your credit card issuer and request an increase. Get all your ducks in a row before you do so: Be able to demonstrate a history of paying your bills on time, have at least 70 percent available credit, and wait until you’ve had the card for at least a year before making the request. You want to avoid being turned down because that signals there was a problem. Plus, every time a company runs your credit because you apply for new credit or ask for an increase in your limit, your credit score drops a little, according to MyFico.

Laura Agadoni has been writing professionally since 1983. Her feature stories on area businesses, human interest and health and fitness appear in her local newspaper. She has also written and edited for a grassroots outreach effort and has been published in "Clean Eating" magazine and in "Dimensions" magazine, a CUNA Mutual publication. Agadoni has a Bachelor of Arts in communications from California State University-Fullerton.


How to Avoid Turning a Credit Limit Increase into a Holiday Debt Hangover

How do credit limits work

The holiday season is at its peak and research firm RetailNext predicts that December 23 will be the biggest shopping day of the year. For many shoppers, a credit card will be the payment of choice. Americans opened 500,000 new store card accounts on Black Friday alone.

Opening a store credit card, even to enjoy a discount off your first purchase or to take advantage of 0% APR financing, can backfire in more ways than one. Not only do these cards tend to carry higher regular purchase APRs than traditional credit cards but owning one could encourage you to spend more than you normally would (and possibly, more than you can afford).

Credit Sesame took a closer look at store credit card trends and how they could affect your holiday spending habits. The average store card credit limit increased over the last two quarters. Average balances have also increased.

Let’s take a closer look at the numbers, followed by tips for keeping your credit utilization in check over the holidays and beyond.

How do credit limits work

Credit Sesame analyzed balance and limit data for three specific categories of credit cards: bank cards, department store cards and Target cards.

In the second quarter of 2016, bank card limits declined by 1% on average, while department store card limits saw an increase of 10%. Over that same period, Target card holders received a 6% average credit limit increase. In the third quarter of 2016, bank card limits increased by 1% on average, while department store card limits and Target card limits jumped by 11% and 7%, respectively.

That’s a significant change over the same time period in 2015. In 2015 Q3, bank card limits increased by an average of 1%, while store card limits decreased by 1% and Target store card limits increased by less than half a percent.

In Q2 2016, we see no major jumps for bank or store card balances. In fact, the average balance for both fell by 4%. Target card users, on the other hand, increased their balances by an average of 11%.

In Q3 2016, shoppers start to cash in on the additional available credit. The average balance for bank credit cards rose by 6%, while department store card balances increased by 11%. Target card average balances saw the biggest increase, spiking by 21%.

How do credit limits work

At first glance, the data suggest that more available credit could cause shoppers to charge more to their cards. People certainly charge more in the third quarter, presumably in anticipation of the holidays.

The fact that credit card limits increased over the same time frame is very likely a strategic move on the part of credit card issuers, but also reflects creditworthiness overall (the bank is not likely to increase the credit limit for consumers with poor credit habits).

According to the New York Federal Reserve, total credit card debt in the U.S. increased by 2.5% in Q3 2016, topping $747 billion. In fact, every type of non-housing debt—including student loans and car loans—rose between July and September of 2016. The aggregate credit card limit increased for the 15 th consecutive quarter.

On par with the national averages, Credit Sesame’s credit card data for 2015 shows that limits and balances rose in 2016. The takeaway: Americans have more available credit and are using it.

Tips for managing your credit utilization over the holidays and into the New Year

How do credit limits work

Running up credit card debt over the holidays or at any of time of year can hurt you in more ways than one. First and foremost, if you don’t pay your balance in full right away, you risk paying expensive finance charges. A card with a 0% introductory APR for purchases can cut down on the cost but only if you pay it off before the promotional interest period ends.

Note that many store cards offer deferred interest promotions. That means that if you don’t pay the entire balance off before the promotional period ends, you’ll be charged interest on the entire amount, from the date of purchase. On a straightforward zero percent offer, you will only pay interest on the balance you carry after the promotional period ends, so some savings are still possible.

Another potential downside involves your credit score. Approximately 30% of your FICO credit score is based on your credit utilization. Higher credit limits can work in your favor only if you keep your balances proportionately low. The higher your balances, the more harm to your score.

A lower credit score could stand in the way of your financial goals or increase their cost.

Control your credit utilization over the holidays to minimize any negative impact to your score. Here’s what you can do.

Know your limits. Healthy credit utilization starts with knowing your credit limits and balances for each card. If you open a new bank or store card, crunch the numbers to figure out how much you can charge before you hit 30% of your limit, and keep your spending below that amount. If you need to charge more than that, pay the bill before the statement closing date (well before payment due date).

Set up balance alerts to track spending. It’s easy to lose track of spending during the holiday rush. Set up text or email alerts to keep tabs.

Request a credit line increase. Paying down balances is not the only way to lower your credit utilization. You can also ask your credit card issuer to increase your available credit. Two things to remember: (1) this will usually result in a hard inquiry on your credit report; (2) your utilization only goes down if you avoid adding to your balance after the limit is increased.

Open new store cards carefully. Consider the benefits strategically before you sign on the application’s dotted line. Be sure the new card fits within a responsible spending plan. Also, be mindful of the number of inquiries you allow on your credit report. Each inquiry is likely to hurt your credit in the short term. Too many inquiries could lead future creditors to reject your application. Some creditors, for example, will automatically reject your application if you have more than two inquiries in the last six months or three in the last year.

Pay early. Waiting until the due date to make a payment to your store credit cards may simplify your life financially but it also causes maximum damage to your credit utilization ratio. Balances are reported on or right after your statement closing date; payments are due about three weeks later. If you pay your bill before the balance is reported, or in portions at multiple times during the month, your credit utilization will be reported at its lowest.

Your credit utilization significantly impacts your credit health and score, no matter how high or low your limits are. Don’t fall for temptation when more credit is made available to you. The folks with the highest credit scores have available credit but leave it unused.

To find out how your spending patterns may be affecting your score, get your free credit report card from Credit Sesame today.

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