Credit card: Should you accept offer to raise credit limit?

Credit card issuers initially sanction lower credit limits to new card applicants. They are offered higher credit limits later on, as and when card issuers are assured of their repayment behaviour and income growth. However, by accepting such offers of higher credit limits, there can be a fear of falling into a debt trap following higher credit card spend.

Take a look at some of the advantages and disadvantages in increasing credit limit.

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Advantages

Improves credit score

Credit bureaus factor in your credit utilization ratio (CUR) while calculating your credit score. This ratio is the proportion of total credit limit used by a cardholder. Lenders generally consider CUR exceeding 30% level as a sign of credit hungriness and hence, more susceptible to default. Hence, credit bureaus to reduce credit score on breaching the 30% level for CUR.

“Containing CUR within the 30% level is crucial for improving/building your credit score. For those who frequently breach this level, the most pragmatic way to contain their CUR within the 30% level is to accept the credit card limit enhancement offers from existing card issuer(s) or apply for the same. In case your existing credit card issuers refuse to increase your credit card limit, apply for additional credit card(s) from other card issuers,” said Sahil Arora, director, Paisabazaar.com.

For instance, assume you usually spend around ₹50,000 every month on your credit card has a credit limit of ₹1 lakh. The CUR would be 50%. Now, if your issuer enhances your credit limit to ₹1.7 lakh, your CUR will come down to 29%. Likewise, if you avail of an additional credit card with a credit limit of ₹70,000, you will view a similar effect on your CUR i.e. it will decrease to 29%.

Easy to deal with financial shortfalls

The increased credit limit can act as a source of emergency fund during financial shortfalls or due to financial exigencies arising from job loss, illness, accident, disability, etc. A higher credit limit will allow you to meet the fund shortages by routing those unforeseen spends through your credit card while keeping your liquidity intact.

Also, those lacking the capacity to repay the credit card bill by the next due date can convert their entire card bill or part of it into Equated Monthly Installments (EMIs). This way one can reduce the interest rate on their outstanding balance to certain extend, without incurring steep finance charges of 30-49% p.a.

You may get a higher loan sanctioned

An enhanced credit limit allows you to avail higher loan amount through a loan against a credit card, given that such loans are generally sanctioned against the credit cardholder’s credit limit. "Loan against credit cards are pre-approved loans offered only to select credit cardholders having good repayment and spend track record. They are usually disbursed within the same day of making the loan application, which makes them an ideal instrument for dealing with financial exigencies and shortfalls," said Arora.

Disadvantages

High credit limit leading to more debt

Although an increased credit card limit can enable you to spend more, it can also land you into more debts, if not used mindfully. “With increased credit limit, one might end up spending impulsively, more than they can afford to pay off. If you are unable to pay your dues on time, it would significantly affect your credit score, and make it difficult to secure better credit options in the future,” said Sujay Das, Chief Risk Officer, MoneyTap- a Bengaluru based credit-line firm.

Moreover, the credit limit can be increased by taking too many credit cards. So, when you take too many credit cards, it increases your dependency on credit cards. This further translates into taking more debt. Hence, it can be very easy to ruin credit, which ideally takes a lot of time to build it back. Therefore, treat your increased credit limit responsibly.

Pay more interest

If you don't pay your balance in full every month, you will end up paying more interest on your outstanding amount. So, if you have increased your credit card credit limit, there can be chances that you won't be able to pay your bill in full. This way, you might have to pay more interest to the issuing bank. Therefore, as a user, be mindful of your habits and always try to pay your credit card bill in full every month.

Loss increases if your credit card is misplaced

In case your credit card gets stolen, the loss incurred will be more as the credit limit is high. Therefore, act responsibly while using a credit card with a high credit limit.