Your Credit Limit on Credit Card?

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Just keep in mind that credit bureaus take the credit utilisation ratio into account: higher the ratio, lower the score

 

Devendra Kumar spends almost `40,000 on his credit card every month. Though he also pays off the entire bill on time, the high credit utilisation of almost 80% (his credit card limit is `50,000) is a red flag for lenders. It implies that he is at the risk of maxing out his card limit and could have trouble repaying the due amount. Credit bureaus take the credit utilisation ratio into account when calculating an individual's credit score. A high credit utilisation ratio means a lower score. A credit utilisation ratio of 20-30% is preferable. In case the ratio is higher, the applicant is seen as credit hungry. It is possible that banks would charge a higher interest on loans to such individuals because they are seen as risky customers.

Now, if Kumar's card's credit limit is increased, his credit utilisation ratio would come down. For instance, if the credit limit was `1.5 lakh instead of `50,000, Kumar's credit utilisation ratio for spending `40,000 a month would be 27%. Most banks revise the credit limit from time-to-time based on the user's repayment history , transactions, outstanding loans and rise in income. A cardholder can also request the issuing bank for a hike in credit limit. There is usually no additional cost involved, though an increase through a card upgrade may attract charges.

THE BENEFITS

BETTER CREDIT SCORE

A lower credit utilisation ratio improves the card holder's credit score, making him a less risky customer in the eyes of the lender. A higher credit limit can also be used as a bargaining tool to get a bigger loan from the issuing bank.

HELPFUL IN EMERGENCIES

A credit card with a big limit comes in handy during emergencies like a sudden hospitalisation where large payments have to be made upfront.

MORE BUYING POWER

A card with a higher limit makes big purchases, like white goods for the home, easy to make.

THE DEMERITS

ENCOURAGES RECKLESS SPENDING

It is a bad idea for compulsive shoppers who can easily throw their budget off track by recklessly buying with their credit cards. This again has a negative impact on the credit score.

SECURITY RISK

If the safety of the card is compromised, the damages can be high. To mitigate the risk of fraud, users should set up alerts whereby the bank informs them when a transaction that does not match their usual spending pattern is noticed.

HIGH INTEREST OUTGO

As the increased credit limit can also mean greater spending, the chances of the card holder being unable to repay the amount in full in a month also increases.This translates to high interest outgo.

Another way of increasing one's credit limit is by opting for multiple credit cards. However, there are pitfalls here too. You will spend more and there is a high chance of default if you cannot manage payments and credit period well. This will negatively impact your credit score. A single credit card with a higher limit is a better solution. You will also save on annual fees of multiple cards.

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