Clearing Up Commom Credit Limit Misconceptions

By Mike Peterson
In September 27, 2011

Are there really “no-limit” credit cards?  Is a high credit limit better than a lower one?   Will a high credit limit hurt your credit score?  This month, I thought I’d spend some time discussing some of the more pervasive beliefs about credit limits.

But first things first.  Before you start reading, take this quick, 5-question quiz to find out how much you really know about credit card limits:

1.   When it comes to your credit score, which is more important?

    A:  The amount of your credit limit
    B:  The ratio of credit limit to credit use

2.   A high credit limit is bad for your credit score.

    A:  True
    B:  False

3.   Your credit limit = your spending limit

    A:  True
    B:  False

4.   If you pay your credit card on time every month, use credit responsibly, and pay down large balances, your credit limit will go up.

    A:  True
    B:  False

5.   There is no such thing as a “no-limit” credit card.

    A:  True
    B:  False

 

Okay, class.  Time’s up.  Let’s see how you scored.

Question 1:  When it comes to your credit score, which is more important?

The correct answer?  B.  The ratio of credit limit to credit use

That’s right.  When determining your credit score, credit reporting agencies don’t care whether your credit limit is $100 or $100,000.  They care about how much of your available credit is actually being used.  Think of it this way:  If you’ve got a balance of $99 on a card with a limit of $100,000, you look like a responsible user.  Even though you’ve got loads of available credit, you’re not out there charging up a storm.  But if that $99 balance is on a card with a $100 limit, you look like someone with a maxed-out credit card.

Question 2:  A high credit limit is bad for your credit score.

The correct answer? B.  False.

The truth is, there’s nothing inherently bad about a high credit limit.  A high credit limit usually means that you’ve demonstrated an ability to use credit wisely.  A high credit card limit is your credit card company’s way of recognizing that you’ve paid on time, you don’t consistently carry an astronomical balance, etc.  The real problems occur when you have a high credit card balance, which brings us to . . .

Question 3:  Your credit limit = Your spending limit

The correct answer? B. False.

I think one of the biggest problems with credit card debt comes from a fundamental misunderstanding of what a credit card limit actually is.  As we discussed in question 2, your credit limit is not what gets you into trouble.  Your spending gets you into trouble.  If you’re carrying a high credit card balance, your credit score will suffer.

Regardless of how you use your credit card, your balance should be much lower than your actual credit limit.  Personally, I recommend keeping a zero balance (proper use of a credit card means paying it off in full each month).  But if you do have a balance, try to keep it at no more than 30% of your limit.

Question 4:  If you pay your credit card on time every month, use credit responsibly, and pay down large balances, your credit limit will go up.

The correct answer?  B.  False.

There’s no guarantee that paying on time and keeping a small balance will have any bearing on your credit limit.  In fact, after years of extending too much credit to their customers, most credit card companies are dramatically reducing spending limits for cardholders, regardless of their payment history,

Question 5:  There is no such thing as a “no-limit” credit card.

The correct answer? A. True.

The concept of a credit card without a credit limit is really just a marketing ploy.  Every credit card has a limit.  Credit cards that are advertised as “no-limit” are really just credit cards with a flexible limit that varies based on factors like income, spending habits, and payment history.  Your limit on a “no-limit” card may go up if you’ve demonstrated responsible use.  And it may go down if you have a history of late payments and high balances.

Use Credit Wisely

The key to keeping your debt in check?  Responsibility.  Your credit limit isn’t a license to go on a shopping spree.  The real key to keeping your credit card debt in check (and keeping your credit score high) is responsibility.  Read the fine print.  Keep a low balance.  Pay on time.  Set your own limits.

Mike is the author of “Reality Millionaire: Proven Tips to Retire Rich” and he has been published in a variety of local and national publications including Entrepreneur Magazine, Deseret Morning News, LDS Living Magazine, and Physicians Money Digest. He holds a B.S. in business administration from the University of Phoenix.