Does Increasing Your Credit Limit Affect Your Credit Score?

Your credit score is closely linked to your financial health, so it’s crucial to always be on the lookout for ways to improve your score. Increasing your credit card spending limit can potentially positively affect your credit score by lowering your credit utilization ratio. However, it will only have a positive affect if you keep your spending levels the same as or lower than before you got the higher limit. If you raise the credit limit on your card and likewise increase your spending (which, lets be honest, can be very tempting with a higher limit) you’ll find that your credit utilization ratio remains unchanged or — worse yet — increases.

So why do credit limits and your credit utilization ratio have such a major influence on your credit profile? We’ll review what a credit score entails and why it’s so important for your financial well-being. We’ll also discuss the importance of distinguishing between pre-approved versus requested credit limit increases to ensure that you make informed decisions when managing your credit. 

What is a Credit Score? 

A credit score is a three-digit number that tells a lender about your creditworthiness. Credit scores in Canada go from as low as 300 up to 900, with 900 being a perfect rating. The lower your score, the less chance lenders, like banks and credit card companies, will see you as creditworthy. Potential lenders will typically review your credit score before they lend you funds or give you a credit card because it tells them how good you are at managing your finances. 

Credit scores in Canada are maintained by two major credit bureaus, TransUnion and Equifax. These credit bureaus calculate your score using complex mathematical algorithms that are based on financial information sent to them by your creditors. There are five principal factors that go into your credit score, each with a different influence on your overall rating. These factors include:

1. Payment History (35%): The most important factor, it and reflects whether you've paid your bills on time.

2. Credit Utilization (30%): The second most important influence on your score is credit utilization which is the percentage of credit you're currently using compared to your total credit limit. 

3. Credit History (15%): How long you’ve had your credit accounts.

4. Credit Mix (10%): It’s wise to have a variety of credit types, such as credit cards, installment loans, and mortgages.

5. Credit Inquiries (10%): Recent applications for credit can cause hard inquiries on your credit report, which can have a temporary negative effect on your score.

Credit Utilization and Its Impact 

Your credit utilization, also known as your credit utilization rate or ratio, is a crucial component in determining your credit score. It is a measure of how much of your available credit you’re using at any one time. So, for example, if you have four credit cards each with a limit of $2500, your overall credit limit would be $10,000. If you currently have a total balance across your cards of $4,000, that would give you a credit utilization ratio of 40% (cause you’re using 40% of your available credit). Creditors generally want to see a ratio below 30%. When your ratio is too high (like a 40% ratio) it makes creditors nervous because it could mean you’re overextended and may have a hard time paying off your debts. 

The Impact Of A Higher Credit Limit

Which brings us to why increasing your credit limits can help your credit score. Let’s say you request and are granted a credit limit increase of $2,000 on two of your existing cards, bringing the limit of both to $4,500. Now, continuing from the example above, your total available credit across your four cards becomes $14,000 ($4,500 + $4,500 + $2,500 + $2,500), while your outstanding balance remains at $4,000.

In this example, with a total available credit limit of $14,000 and an outstanding balance of $4,000:

Credit Utilization = (Outstanding Balance / Total Available Credit) * 100

Credit Utilization = ($4,000 / $14,000) * 100

Credit Utilization = 28.57%

The Impact Of Higher Spending

In the above scenario, your credit utilization ratio is approximately 28.57%, which is below the recommended threshold of 30%. By raising your credit limit, you’ve lowered your ratio, which will increase your score.

However, imagine the same scenario but in this example, you increase your spending, causing your outstanding balance to rise along with your credit limit. If you use the newly increased credit limits to accumulate additional spending and more debt and your outstanding balance climbs to $6,000, your credit utilization ratio would be recalculated as follows:

Credit Utilization = ($6,000 / $14,000) * 100

Credit Utilization = 42.86%

This ratio is well above the ideal 30% and therefore will decrease your score. 

The Key: Keeping your Spending the Same

From the above examples, it’s clear that the key to using higher spending limits to increase your score is to not increase your spending. Having a ratio higher than 30% now and again (because of a big unforeseen expense or the holidays, for example) isn’t a big deal. If you overspend consistently, however, there’s no doubt that your score will take a hit. Not to mention that you could be accumulating debt that you can’t easily pay off, which would lead to even more of a steep decline in your score.

Pre-Approved Limit Increases vs. Hard Credit Checks 

When asking for a credit limit increase there are some essential factors to keep in mind. Even if you don’t increase your spending when you get higher limits, it’s possible that just the very act of asking for an increase could negatively impact your score. That’s because, in some cases, the credit card issuer may perform a hard credit check to assess your creditworthiness before giving you the increase. Hard credit checks can lead to a temporary drop in your credit score. Therefore, it's smart to ask your issuer about their specific policies regarding credit limit increases and whether they'll conduct a hard inquiry. That being said, credit inquiries only account for 10% of your overall score, so the affect will be small and temporary. 

On the other hand, if your credit card issuer reaches out to you with a pre-approved credit limit increase, they will only perform a soft credit check which won’t affect your credit score. This can be a perfect opportunity to increase your limits without hurting your score. The best way to make yourself an appealing candidate for a pre-approved increase is to always pay your balance off in full and on time. Also be aware that you don’t have to feel pressure to say yes to an increase. If you think you’ll be tempted to overspend, it’s wise to decline higher limits. 

Conclusion 

Increasing your credit limits can be a good way to increase your purchasing power and your credit score, however, responsible management of your spending is key. Also keep in mind that if you request the credit increase, your credit card provider may do a hard check on your credit report and your score will be negatively impacted in the short term. By maintaining consistent spending and avoiding the temptation to accumulate debt, you can reap the benefits of higher credit limits without compromising your financial health.