When you apply for a credit card, you may be wondering how banks decide credit limits. Banks make a determination on your credit limit by evaluating how much they reasonably believe you can afford to borrow and pay back. The credit limit is also determined by how risky they believe it is to lend to you. There are two major factors that come in to play when a bank is deciding your credit limit: your income and your credit score.
- Your income is important because your income is required to pay back debt. If you make more money, banks assume you can afford to pay back larger debts and make larger minimum payments. Banks may verify your income by calling your employer, or looking at pay stubs or tax records. However, often when you apply for a basic credit card online, banks will simply take your word for how much you make.
- Your credit score is the biggest factor in determining your credit limit. The higher your credit score, the more responsible you appear to lenders and the less risky it is for lenders to lend you money. Your credit score is determined by your payment history (35%), your debt to credit ratio (30%), the average age of your credit accounts (15%), the types of credit you use (10%) and the number of inquiries listed on your report (10%). Banks will request this number from one of the three major credit bureaus- Equifax, Transunion or Experian- who keep a record of your borrowing behavior. They then look at this number to determine whether you are a good credit risk and to set your line of credit.
- Scores above 700 are usually considered to be good credit scores. With a score above 700 and a high income, you should be able to qualify for the highest credit lines at the lowest possible rates. With scores below 650, it may be more difficult to qualify for some credit cards or to get a high line of credit. Secured credit cards, in which you put up collateral (cash) in a special account are a good option for those with poor credit. With a secured credit card, your line of credit is equal to the amount of collateral you put in the account. A secured credit card can help you improve your credit or build a credit history so you can one day qualify for a larger line of credit or a card with more favorable terms.
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