Will a Credit Card Limit Increase Help or Hurt Your Finances?
by Julie Jaggernath
Have you ever received an offer in the mail or online to increase the credit limit on your existing credit card? If you have and you’re also trying to figure out how to deal with your debts, you might be tempted to take advantage of the offer to get your finances back on track. But will more available credit really solve your debt problem? It depends.
When plastic started being used for payments in Canada in the late 1960’s, there was no extension of credit. They were called charge cards and the full amount was due and payable every month. It didn’t take long, though, for charge cards to morph into credit cards and as they say, the rest is history.
However, what isn’t history is the resulting debt. In 2019, credit card balances in Canada topped $100 billion for the first time ever. And while balances have decreased a little since that time, information shared by the credit bureau companies indicates that the debts have merely been shuffled over to a lower interest line of credit and not truly paid off. That’s one of the problems that can happen when you rely on additional credit to fix an existing debt problem.
The Problem with Credit Card Debt
When you carry credit card debt over from month to month, your future buying power is drastically reduced. Not only do you have to pay back what you charged on your cards, you need to spend more of your income to cover off the interest and fees. Suddenly everything you buy can be as much as 50 per cent more expensive than the original sticker price.
When it comes to increasing the limit on your credit cards, think about how you handle your money. Could you afford the higher payments if you charged your cards up to the higher limits? If a lot of available credit tempts you to spend more than you normally would, you might do yourself more harm than good. If you’re satisfied knowing it’s there if you need it and you incorporate additional payments into your budget when you do use it, then a higher limit might be right for you. Before you make your decision, here’s what you need to know about the impact a higher limit may have on your finances and decisions overall.
Why Do Some People Get Credit Card Limit Increase Offers and Others Don’t?
Credit card companies, banks, and credit unions routinely verify their clients’ accounts to see where opportunities for more business may exist. They do this by making “soft” inquires on customer accounts who have consented to credit checks for everything from opening a bank account to applying for a line of credit or mortgage. Part of the consent a customer signs allows for these ongoing checks.
A “soft” inquiry means the creditor only verifies their own products or accounts with the credit bureaus that a client may have, and the inquiry does not affect someone’s credit score. If you’re curious to see which creditors are spot-checking your accounts, request a copy of your own credit report for free. These “soft” inquiries will be listed for you. By conducting a “soft” check the creditor can quickly determine if the credit account is being used properly, if someone is falling behind, or if there’s room to offer the client more credit.
If the “soft” check reveals that you get behind with your payments fairly often, the lender might tighten up their terms and conditions. This tightening up might include advising you of an interest rate increase. For instance, many credit cards now stipulate that if you miss 2 minimum payments in a 12-month period your interest rate (APR) will increase by 5%. A lender might change other terms or conditions if they are worried about your inability to stay on track with your payments. One such change could be limiting how much of your available credit can get used for cash advances versus charges. Another might be blocking you from redeeming any rewards you’ve collected.
If a credit card company becomes extremely worried that you aren’t living up to your contractual agreement, they could suspend your account entirely. This means that the full balance owing is due and payable immediately and no further purchases are allowed. Once you pay off what you owe, the account is typically closed.
What to Do When You Receive a Credit Card Limit Increase Offer
If you use credit wisely you likely won’t know that a lender has checked up on you. However, if the “soft” check reveals a high credit score, you will receive limit increase offers. But there’s a fine line between what a lender says you can afford and what you know you can afford. You don’t need to accept what they offer you, or you could accept a reduced amount to stick within your comfort zone.
To help you decide whether or not to accept a limit increase offer, here are 4 key things to consider:
- Available Credit Can Get You Through an Emergency
It’s easy to think that you’ll apply for more credit when faced with an emergency, but that will often lead to a decline. For instance, if you lose your job and need a line of credit to get by until you find another job, without income your lender will be unable to grant you the loan.
To prepare for the unexpected, having credit available to you that you don’t routinely use, along with emergency savings to cover your basic expenses for a few months, is wise financial planning that will help you navigate the bumps in the road.
- Higher Limits Can Improve Your Credit Score
Higher limits on your credit cards will decrease your credit utilization ratio, which is one factor in the calculation of your credit score. Credit utilization simply means how much of your available credit you’re using at any point in time. The lower the ratio, the better. For instance, if you have 2 credit cards with a combined limit of $10,000 and a total amount owing of $7,800, your credit utilization ratio is 78%.
But if you increase the limit on 1 of the cards so that the combined limit is now $15,000, with the same $7,800 still owing, your ratio drops to 52%. Keeping your balance owing on each account below about 65 per cent of the limit helps to protect your credit score.
How Credit Scores are Calculated in Canada
- High Limits Can Prevent You from Obtaining Other Credit
Where a higher limit on your credit cards can help increase your credit score to make other borrowing more attractive, those same higher limits can mean that you qualify for less additional credit. While this might sound backwards, the reason makes sense. You only have so much money to make payments with. If you’re close to that limit with the products you already have, there’s less room to lend you more.
That limit, when a lender is unable to lend your more, varies. At your bank or credit union the limit is normally 40% of your gross income. If you earn $4,500 before tax each month, that means a maximum of $1,800 can be committed to your payments. This calculation is called your total debt service ratio (TDSR) and it includes your rent, cell phone payment if you have a contract with your service provider, current monthly loan payments, and the minimum requirement payment on your credit cards.
12 Key Things to Know Before Applying for Credit
When some lenders calculate this ratio, they base your minimum credit card payment amount not on what you normally owe, but on the limit of your card. The higher the limit, the higher the (potential) minimum payment – and the less additional credit they can lend you. It can mean the difference between buying the car you want and the one that simply moves you from A to B.
Lenders use the potential minimum payment amount because you already have that credit available to you. If you were to utilize it after they approve you for the additional credit you may run into problems keeping up with all of your payments. Ultimately, this is for the creditor’s protection but it also benefits the borrower.
- More Available Credit Can Lead to Temptation Spending
More available credit means you’ve got more ability to buy things now and pay for them later. And that’s the tricky thing with credit. We all know how it works, but for many, the temptation to spend what’s available to them is simple too great to resist. If you add in enticements like loyalty points or travel rewards and the ability to fulfill our wishes instantly, it’s a recipe for debt.
If a lot of available credit makes you feel richer than you really are, it’s probably best not to accept a limit increase and work within what you already have available.
What to Do When You Have Second Thoughts About Credit Card Limit Increases & Dealing with Debt
It’s easy to blame your credit cards for your debt problems, but the cards themselves aren’t the problem. They are just small pieces of plastic with shiny logos, one available tool your financial toolbox. Another tool in your toolbox is a non-profit credit counsellor who will help you figure out your best course of action. Contact us now at 1-888-527-8999 to set up a free appointment where a counsellor will review your situation with you. You can also contact our email address or talk to us online. Whether you need help to deal with your debts, figure out a budget, or decide what to do about credit card limits, we’re here for you.