It can be a real breath of fresh air when you open up a letter from a credit card company and find out that they just increased your credit card limit. After all, the mail often brings less satisfying correspondence, like bills. Not only does an increased credit limit bring greater spending flexibility, but it’s also something of a vote of confidence by the bank in regard to your credit history. But if your credit card limits are increasing, is that really a good thing?
Sometimes. But sometimes not.
The Credit Limit Increase You Didn’t Ask For
A credit limit increase comes in two forms, the first of which is the credit limit increase on an existing credit card that you didn’t ask for. You receive a letter from the bank, and poof, your credit limit has been increased from $5,000 to $10,000!
Along with the notification there’s usually some sort of complementary language to the effect of Due to your outstanding credit history, Worldwide Amalgamated Bank has increased your credit limit. Who wouldn’t feel good about that???
If this happens across multiple credit lines, you might see an increase in your collective credit limits from $25,000 to $50,000. That’s a lot of additional buying power.
And that’s part of the problem.
The Unsolicited Credit Card Pre-Approval
The second type of credit limit increase comes in the form of unsolicited credit card pre-approvals. These aren’t increasing your credit limits, but are entirely new credit lines. But new credit lines increase your total credit limit in much the same way as increases on existing cards.
Credit card pre-approvals can be even more flattering. After all, the credit card lender has pre-selected you from a list of presumably thousands of potential customers (or so we like to believe). They’ve determined that you’re worthy of more credit, based upon your current good credit history, or possibly some other factor, such as your occupation or zip code.
Whether it’s a credit limit increase in an existing credit line, or an entirely new credit line, it serves as a validation of your worth as a customer. A lender, or several of them, have deemed you to be a good credit risk, and are showing their appreciation by making even more credit available to you.
And that’s another problem.
Why Increasing Your Credit Limits Isn’t Always Such a Good Thing
Why is an increase in your credit limit, or a new credit card, such a problem when it feels so good? Because the lenders are effectively setting you up for a potential credit disaster. As well, the fact that increased credit limits can be an ego booster can cloud your judgment.
There’s also a bit of rational reasoning to this. There’s a school of thought – in fact, there’s a closet industry – devoted to the idea that you should be involved in ongoing efforts to improve your credit score. One of those popular methods is manipulating your credit utilization ratio. That’s the amount of credit that you owe, divided by the total amount of your credit limits. It accounts for 30% of your overall credit score calculation.
As an example, if you owe $20,000 on your credit cards, and those cards have a combined credit limit of $25,000, your credit utilization ratio is 80% ($20,000 divided by $25,000).
An 80% credit utilization ratio is considered a distinct negative in calculating your credit score. The credit bureaus generally like that ratio to be around 30% or less. If you want to improve your credit score, one of the best ways to do this is by reducing your credit utilization ratio.
There are two ways that you can do this. The first is the simpler strategy – you pay down your credit lines. That will lower your credit utilization ratio, and improve your credit score.
But the second way is less painful: you increase your credit lines.
Continuing the example above, if you were to increase your total credit limits to $50,000, your credit utilization ratio would drop to 40% ($20,000 divided by $50,000). Your credit score might increase by 50 points as a result, and – wow(!) – you didn’t have to pay off $10,000 worth of credit card debt to make it happen.
The moral of the story: It’s usually easier to improve your credit utilization ratio by increasing your credit limits than it is to actually pay off your debts.
You see what’s happening here? Just about every strategy in the credit universe is encouraging higher credit limits.
That’s the problem.
When is Enough Credit Enough???
Some people can have very high credit limits, and they have the willpower, the discipline, or the income to avoid running up their debts. But not everyone does.
One of the problems with higher credit limits is that they’re very empowering. The fact that you have them – that the banks grant them to you – can give you an exaggerated sense of financial power. It may be more difficult than you think to resist using those credit lines.
Even if you have no intention of using them at the time you get them, that could change later. For example, you could go through a period of emotional stress that will cause you to spend money that you don’t have. The additional credit lines will allow that to happen.
You can also go through a time of employment troubles. The availability of high credit limits, in combination with an unemployment check, might cause you to avoid cutting back on living expenses. Once again, the high credit limits will make that possible.
But too much of a good thing isn’t good for you. If you’re making $50,000 per year, and you even come close to using your $50,000 in combined credit limits, you’re teetering on the edge of bankruptcy.
The monthly payments on outstanding credit debt approaching $50,000 will be close to $1,000 per month. That’s the size of a modest house payment, but it’s entirely possible if your credit limits are increased that high, and you end up going on a spending spree.
What to Do When Enough is Too Much
Credit card debt is particularly difficult to work your way out of, especially when the amount owed is that high. Not only does the monthly payment become a problem, but high interest rates that credit cards carry keep you from making much progress in paying down your balances. Most of your monthly payments will go to pay interest, doing little to reduce your debt.
If you get even close to that situation, it’s critical to get out of it as soon as possible. There’s no way you can win with that kind of arrangement. Eventually, you’ll fall behind on your payments, your credit scores will drop, and your interest rates will go even higher. That will also effectively put an end to steadily increasing credit limits.
When that happens, you will hit the credit wall, and you will know that enough has become too much. When you reach that point, getting legal help might be your best course of action. Credit card companies will be extremely unlikely to work out a debt reduction solution for you, and will generally be uncooperative.
But if it reaches that point, a good credit attorney will be your only logical alternative. Since they know the law regarding credit, they can work out the best solution for your situation.
But don’t let it get that far. And don’t keep thinking that increasing your credit card limits is really a good thing. It eventually reaches a point where it becomes a disaster waiting to happen. And that’s when you’ll have to call on legal help to straighten the situation out.