When it comes to credit, specifically credit cards, you might assume less is more. That having as few cards as possible with minimal credit limits is a way to protect your credit score and your overall financial health. However, this might not always be the case.
Depending on your spending habits, increasing your credit limit may actually improve your financial wellbeing.
Here are some ways to evaluate whether increasing your credit limit is a good idea.
What’s your average monthly spend on your credit card?
Do you reserve your credit card for the occasional large purchase, or do you use it regularly for your day-to-day spending? If you answered the latter, you probably do so to take full advantage of the rewards your card offers (and rightly so) – maximizing your credit card rewards pays off!
What really matters is the monthly amount you’re charging and how that measures against your existing credit limit. The comparison of those two numbers gives you your credit utilization rate (sometimes called credit utilization ratio). The reason it’s important is because having a high credit utilization rate can negatively impact your credit score – even if you pay your balance off in full each month.
For example, if your credit limit is $5000 and you spend an average of $3500/month, then your utilization rate is 70% (3500/5000 = 0.70). A general rule of thumb to maintain a good credit score is to keep that rate below or around 30%. Meaning if you plan to continue spending $3500 every month, you should consider increasing your limit to lower your utilization rate.
Who’s offering you the credit limit increase?
If you’re presented with any credit pre-approval (whether it’s a limit increase or a new credit account), your next consideration should be where it’s coming from.
If the offer is from a financial institution you currently have an account with (credit or otherwise) then you can generally expect they didn’t run what’s called a “hard” check on your credit score, but rather decided to make the offer based on the history you have with them.
Why does this matter? Because any inquiry on your credit score (especially a hard check) dings points off your score. The credit bureau views any application for new credit as a sign of financial difficulty (even if that’s not the case). So where applying or accepting an offer for a new credit card from a new financial institution can negatively affect your credit score, doing so from your own institution won’t have the same consequences.
The same reasoning stands if you’re looking to obtain more credit. Rather than apply for a new credit card, you may be better off talking to your financial institution about raising the limit on your existing card.
What does your emergency fund look like?
Not to say a credit card is a suitable replacement for emergency savings, but it can be a great back up – just in case. Particularly when it comes to processing unexpected payments such as auto or home repairs that usually come with a hefty price tag.
The convenience of not having a transaction or daily spending limit (as is common with most debit cards) means a credit card can be a helpful tool when you’re faced with unanticipated expenses. Having the flexibility of a higher credit limit comes in handy at times like these.
What are your credit habits overall?
Last but certainly not least, before accepting a credit limit increase you should pause to consider your existing relationship with credit.
Does your balance tend to hover around the top end of your limit, no matter how low or high it is? Do you diligently pay your balance every month in full, or do you carry it over? Be honest with yourself.
If your habits indicate you’re likely to add to your debt burden, that will outweigh any benefits of accepting a limit increase. In short – don’t do it.
But if you have healthy credit habits there’s an opportunity to enjoy the benefits an increased credit limit can have on your overall financial wellbeing.