Why You Should Think Twice Before Accepting a Credit Limit Increase
Credit card companies send cardholders all sorts of goodies in the mail. From low interest rates on balance transfers to opportunities for double rewards. If you’ve been a cardholder for many years you’ve probably seen it all.
A favourite with credit card companies is a credit limit increase. You’ll usually receive a letter in the mail letting you know that as a valued cardholder you’re entitled to a credit limit increase. Before you pick up the phone and call your credit card company to accept, there are some important things to consider.
Advantages of a Higher Limit
Reduced Credit Utilization. When you accept a credit limit increase, as long you use it responsibly and forgo increasing your spending, it will reduce your credit utilization. Why does that matter? Credit utilization is one of the key criteria credit reporting agencies like Equifax and TransUnion use to calculate your credit score.
Credit utilization is calculated by dividing your outstanding debt by your available credit. Theoretically, the lower your credit utilization, the higher your credit score should be.
Financial Emergencies. Credit doesn’t just grow on trees. Credit can be hard to come by, especially when you need it most. If you run into an emergency, you’ll be glad you have the financial cushion. Although it’s almost always a good idea to have an emergency fund of three to six months’ living expenses set aside, there are some times when you may need to rely on credit.
For example, if you’re a snowbird travelling to the U.S. and you run into an emergency, your credit card can help you out of a financial jam. You’ll be thankful you have this extra credit at your disposal.
Reward Points on Major Purchases. If used responsibly, a higher credit limit can mean more of your daily spending can be moved to the credit card, and it turn earn more reward points. You can rack up a lot of rewards points by making major purchases on your plastic, instead of writing checks or using your debit card. Paying the taxman with your credit card and paying for major renovations are also great ways to accumulate a lot of points.
Disadvantages of a Higher Limit
More Debt. If you’re constantly carrying a balance on your credit card and only paying the minimum, you should really think long and hard before accepting a credit limit increase. A higher credit limit can lead to more debt if not used responsibly.
If the extra capacity to spend money is there, the temptation may be irresistible. Be sure to follow the number one rule of responsible credit card spending and only make purchases you’ll be able to pay off in full by the end of your grace period.
Hard Credit Inquiries. A credit limit increase can be a double-edged sword. Although it can help your credit score by lowering your credit utilization, it can also lower your credit score if there will be a so-called hard inquiry into your credit history.
There are typically two types of credit limit increase letters you’ll receive in the mail – one that says your credit limit has automatically increased, and another that says you “may” be eligible for a credit limit increase. While the first type shouldn’t hurt your credit score, the second could, especially if you have too many credit inquiries within a short period of time. You should ask your credit card company if a hard inquiry will be needed before accepting a credit limit increase.
While these types of inquiries can have a short term impact on your credit score, they typically don’t do long term damage.
The Bottom Line
When deciding to accept a credit limit increase, it’s important to weigh the pros and cons. If you think you’ll be tempted to spend your newfound credit, you’re probably better off declining the offer. However, if you use your credit cards conservatively, a credit limit increase can help improve your finances through increased rewards earnings, and ultimately your credit score, through improved credit utilization.