The email can catch you by surprise: You get a message from a bank telling you that your credit limit has increased. Banks routinely check the financial health of their credit card customers. When these customers have a good credit score and a history of paying their bills on time, they might decide to raise their credit limit by $5,000, $10,000, or more.
You might welcome a surprise boost in your credit limit, but you should also be wary of this: An increase in your credit limit can cause problems if you’re not careful.
Don’t add to your debt
Do you spend more with your credit cards than you can technically afford? Are you unable to pay off your balance in full each month? If so, an increase in your credit limit has potential to make things worse.
Credit card debt is some of the worst debt to carry because it comes with such high interest rates — sometimes as high as 20 percent or more. If you carry a balance on such cards from month to month, the amount you owe can soar solely because of this interest.
Here’s an example: Say you are carrying a balance of $8,000 on your credit card at an interest rate of 17 percent. Now, say that your minimum monthly payment is 4 percent of that balance. If you only make this minimum payment each month, it will take you over 12 years to pay off your balance. The total interest you will pay during this time is a bit more than $4,272 — and that assumes that you won’t be using that credit card to make any additional purchases.
If a credit limit increase inspires you to spend even further beyond what you can’t pay off each month, you’ll simply be increasing the time it takes to pay off your credit card debt. The smart move after receiving a limit increase is to set your own personal charging limit. Even if your card’s credit limit is $20,000, resolve not to charge more than $500 a month if that’s all you can afford to pay off when your card’s payment date arrives. Don’t add to the mountain of high-interest credit card debt you’re already struggling to pay off. (See also: How to Pay Less Interest on Your Credit Card Debt)
Monitor your credit utilization ratio
If a higher credit limit encourages you to spend more, you might also be hurting your credit score, even if you pay your credit card bill on time each month. This has to do with your credit utilization ratio. Your credit score will fall if you use up too much of the credit available to you. It will rise if you are using less of it.
Getting a credit limit increase would seem to help your credit utilization ratio. After all, if you have more credit available to you, you will automatically be using less of it the day that credit limit increase kicks in. But if that credit limit increase inspires to you to go on a charging binge, you could quickly use up your credit increase in new purchases. That, in turn, will hurt your credit utilization ratio and your credit score.
Again, the key is to set personal limits and stick to them. Determine a reasonable amount of money you can charge each month and don’t charge more than that.
Don’t cancel that card
If you’re worried that you can’t handle a credit limit increase, don’t cancel your credit card. This will automatically increase your credit utilization ratio and damage your credit score. Once you close a card, the amount of credit available to you will automatically drop without you even charging another cent.
You can call your credit card issuer to request that your credit limit be reduced, but that might be a risky strategy. Remember, having a higher credit limit is good for your credit score, as long as you don’t swallow it up by charging too much. By removing that increase, you won’t get the credit score boost that can come with higher credit limit.
Instead, stick to that personal charging limit you’ve set, no matter how much available credit you have. Maxing out your credit cards is a bad financial strategy, no matter how high your credit limits.