Read on to understand the pros and cons of higher credit limit...
Anushka has a credit card with a limit of Rs 100,000 which she applied for almost five years back when her monthly billing used to be around Rs 25,000. Now her billing, almost on an average, is around Rs 60,000. Anushka always pays her bills on time.
Ankita has a credit limit of Rs 50,000 and she mostly manages to max her credit limits and sometimes even struggles to make payments thus carrying them forward to the next billing cycle.
Who do think among these two will benefit from getting a higher credit limit; if at all? I feel it will be Anushka while for Ankita it could be a debt trap. In case you are wondering why then follow the discussion below.
When is an enhanced credit limit beneficial?
As in Anushka’s case, often a person’s lifestyle and expenses increase with time keeping in pace with increased income and also rising inflation. However often users forget to enhance their credit limit which is usually linked to a person’s income. Thus even if the person pays in time like Anushka does, their credit utilisation ratio (billing per cycle/sanctioned limit) is high which impacts the CIBIL score negatively.
Thus for someone who is eligible for a higher credit limit, pays on time but has a high credit utilisation limit getting an enhanced credit limit will be beneficial.
When the credit card billing ratio is high in comparison to the sanctioned limit, it has a negative impact on the CIBIL score. The solution to this could be either to reduce the monthly spending on the card (which might not be the easiest, but still the wisest, thing to do), get a new card issued which will raise the overall available limit and the expenditure must be spread over both cards and the third is to get a bigger limit sanctioned on the same card. If eligibility criteria allows then getting a bigger credit limit seems to be the simplest way to keep the credit utilisation in check. Reducing the billing might not be possible and everyone might want to get a new card issued due to multiple reasons.
When is an enhanced credit limit not such a good idea?
Considering Ankita’s example, a higher credit limit can compound the problem rather than mitigating the problem of a high credit utilisation ratio for someone like her. Her problem is not only a high ratio of spending but spending beyond means and also not paying on time which is a bigger evil. So for someone like her it may lead to spending more than before causing her to be subjected to bigger penalties and more rollover credit. A situation like this can lead to a debt trap too.
A bigger credit limit can be a big temptation for those who indulge in impulsive shopping and are generally not inclined to budget their expenditure. A smaller limit allows lesser option to splurge. Delayed payments and defaults impact the CIBIL score even more adversely than a high credit utilisation ratio.
So if Ankita really wants to do something about her credit score the first thing she needs to do is control and budget her expenditure. Once that is done then she can go on to get a bigger credit limit if her credit utilisation ratio is still high. Tackling the issue of payment default is more important than credit utilisation for her; just going on to get a bigger limit will not work for her. Moreover the card company might not be willing also to sanction a bigger credit limit considering Ankita’s past record.
Thus an enhanced credit limit must be opted when one’s credit card billing is within her/his paying capacity but the ratio is high in comparison to the sanctioned limit.
Getting a bigger limit will help her/him in improving the credit score. However for someone who is already struggling with defaults and is frequently late in paying or resorts to paying only the minimum amount due a bigger limit may not be the best solution. So before applying for a bigger limit evaluate your credit card billing pattern and then decide accordingly.
Photograph: Simon Cunningham/Creative Commons
The author is a credit expert with 10 years of experience in personal finance and consumer banking industry and another 7 years in credit bureau sector. Rajiv was instrumental in setting up India's first credit bureau, Credit Information Bureau (India) Limited (CIBIL). He has also worked with Citibank, Canara Bank, HDFC Bank, IDBI Bank and Experian in various capacities.