05 July 2007

Got a credit card or 4? Raise your limits!

Today I was looking at my online account page for one of my credit cards, and thought, for curiosity, I'd click on the "request a limit increase" button to see what the options were. To my surprise, on the next page I was already approved for an increase that amounted to about 20% of the previous limit. I was then given the option of accepting the increase, canceling, or asking for more. I don't need a limit increase, so there's no point in the extra hassle of asking for more. So I accepted the increase and moved on.

As I was thinking about what just happened, it occurred to me . . . do people realize that they're better off with higher limits? Well, most people are. The exception is if you cannot control your spending to the point that a higher limit just means more spending . . . and in your case you don't need a credit card at all. But if you are like me and carry no balance (or even a small balance) from month to month, raising your credit card limits is a great thing to do. The reason? Your credit score, of course.

Specifically, how much credit lenders are willing to grant you (as well as how much of that credit you utilize) says a lot about your creditworthiness. If your lenders see you as a low enough risk to give you a large credit limit, that reflects positively on you as a borrower. Further, if you have a large cushion between your balance and your limit, it indicates that you can responsibly manage your credit.

For example, Bob and Joe have four credit cards each, and both have a total limit of $50,000. Jim also has four credit cards, but his total limit is just $12,000. Suppose both Joe and Jim carry a balance of $4,000 each month, while Bob carries no balance. Which man has the most attractive credit profile? The least attractive?

Bob: $50k limit, $0 balance
Joe: $50k limit, $4k balance
Jim: $12k limit, $4k balance

  • Clearly, Bob is the most attractive borrower. He has access to plenty of cash, but is financially stable enough that he doesn't need to access it at all.
  • Joe has access to plenty of cash, but unlike Bob he needs to tap into it to some degree. His utilization ratio is $4k/$50k, or 8%. Not bad, but not as good as Bob.
  • Jim hasn't been given the leeway by his lenders that Bob and Joe have, with only a $12k limit. Additionally, he needs to tap into it, like Joe does. But Jim's utilization ratio is $4k/$12k, or 33%. Of the credit available to him, Jim is using 1/3. To some degree, Jim looks like he "needs" money. As such, he is considered to be the borrower most at risk to become delinquent and ultimately default on his debt.
See, a portion of your score relates directly to these two characteristics-- how much you can borrow and how much you do borrow on revolving accounts. The less you borrow and the more cushion you have, the more financially attractive you are as a borrower . . . and the more likely a lender is going to want to do business with you. This can make the difference in a mortgage rate, terms, or points, saving you a substantial amount of money in the process.

It's unfortunate that Jim has to borrow $4k from his credit card companies . . . but his situation would certainly appear better, on paper at least, if he just had a higher limit. Sometimes credit card companies will grant you a higher limit to entice you to do more business, and sometimes you have to ask for it. Either way, as long as you don't use the extra credit, having your limit bumped up is a positive for your score. To make sure you're getting the most on paper for your responsible behavior in reality, see if you can get your credit limits bumped up. Your FICO score will thank you.

16 comments:

Beyond the Consumer said...

From a credit card's perspective, I'd say Joe is the better. He has a high credit limit, low credit to balance ratio, but keeps a nice 4k balance. The credit card companies aren't making any money off of Bob.

Kevin said...

I'll have to disagree with "beyond the consumer". Yes, Joe is attractive in that he has a balance BUT they make plenty of money off Bob if Bob is using his card and paying off monthly -- it's just coming from the retailer's end rather than out of Bob's pocket.

The low utilization, however, means Bob has the better FICO score (all else being equal).

Good article, Brad!

Brad said...

Kevin is right, but Beyond has a good point. In fact, I'd say the distinction between BEST credit and slightly below may make a difference in a credit card company's marketing strategy. They'll be more than happy to give Bob a card and hope he uses it, but they may not actively pursue someone like Bob as much as they'll pursue someone like Joe. They take on a little more risk with Joe, but get more reward as well. I'd say lenders like to strike a balance with risk/reward just like investors do, and people like Joe may optimize that tradeoff.

But the point remains that Bob's FICO score will be better (if only slightly) . . . so you, as a consumer, are better off in his position, and you'll have access to the same opportunities with CC companies that Joe has. You just may not be their optimal customer.

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