The seasonal work I found turns out to be more seasonal than I thought. I’m using my credit cards to get by while I find another job, and I’m getting close to the limits on all of them. Through my online banking, I’ve had offers to increase the limit on two of my credit cards and I figure if they offer, what’s the harm in accepting. And if I need more money, at least I don’t have to reapply. A friend told me that a higher credit limit can even improve my credit rating. Is it worth allowing them to raise the limits? ~Jocelyne
When charge cards first became available in Canada in the late 1960s, they were known as “charge cards” because there was no credit extension. It was simply a form of payment and the full amount was due and payable each month. However, it was not long before financial institutions in Canada became aware of the lucrative “credit cards” offered south of the border. Today, credit cards are an integral part of most Canadians’ financial affairs, with hundreds of millions of credit cards in circulation around the world.
Savvy consumers have discovered how to use their credit cards as payment cards. They reap the rewards and avoid the inconvenience. But many like to curse their cards and all the difficulties they have because of them. Credit cards themselves, however, are not the problem. They’re just little plastic cards with shiny logos that fit in our financial toolboxes.
When used correctly, as with any other tool, the results can be spectacular; but when misused, the consequences can be disastrous. When it comes to paying off credit card debt, your future purchasing power is significantly reduced. Not only do you have to pay back what you charged to your card, but you have to allocate revenue to interest payments and fees. Suddenly, everything you buy can cost up to 50% more than the original price of the sticker.
When it comes to increasing the limit on your credit cards, only you know how you manage your money and whether you can afford a higher limit or not. If lots of available credit sends you into a spending spree, you may be doing yourself more harm than good. If you’re happy knowing it’s there if you need it, and you build extra payments into your budget when you use it, then a higher limit might be right for you. Before making your decision, it can be helpful to understand the impact a higher limit may have on your finances and overall decisions.
Credit limit increase offers are a marketing tool
Financial institutions and credit card companies regularly check their customers’ accounts to see where additional business opportunities may exist. They perform informal account inquiries of customers who have consented to credit checks for everything from opening a bank account to applying for a line of credit or a mortgage. Part of the consent a customer signs enables these ongoing checks.
A soft inquiry means that the creditor only checks their own products or accounts with credit bureaus that a customer may have, and the inquiry does not affect someone’s credit rating. If you’re curious about which creditors are checking your accounts, ask for a copy of
your own credit report for free
. These soft inquiries will be listed for you. By performing a smooth check, the creditor can quickly determine if the credit account is being used properly, if someone is falling behind, or if more credit can be offered to the customer.
If you fall far behind, chances are the lender will tighten their terms. This may mean notifying you of an impending interest rate increase or credit limit decrease, changes to other terms or conditions, or in extreme situations the lender will “recall the loan”. This means that they will make the total amount due due and payable immediately. When it is a credit card, it can no longer be used to make purchases and reimbursement of the full amount due is required.
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Those who use credit cautiously usually won’t know the lender has checked. However, those for whom the soft check returns a high credit score will become the target of marketing offers. Remember though that just because they offer a limit increase for your credit cards doesn’t mean it would be wise for you to accept it. There is a fine line between what the lender says you can afford and what you know you can afford.
Here are four key considerations when deciding whether or not to accept a limit increase offer:
1. More credit available means more emergency help
Credit is not the same as money, but in a pinch, having credit available to you can be crucial. Ironically though, when you really need more credit, that’s often the hardest time to get it. For example, if you are laid off and need a line of credit to make ends meet until you are called back, once your earnings are gone, your ability to get a new line of credit also decreases.
To prepare for the unexpected, have a loan that you do not use regularly, as well as
to cover your basic expenses for a few months. It is sound financial planning that will help you overcome the obstacles in the road.
2. A higher limit can improve your credit score
Higher limits on your credit cards will lower your credit utilization rate, which is a factor in calculating your credit score. Credit usage simply means how much of your available credit you are using at any given time. The lower the ratio, the better. For example, if you have three credit cards with a combined limit of $12,000 and a total amount owing of $9,000, your credit utilization rate is 75%.
However, if you increase the limit on two of the cards so that the combined limit on all three cards is now $18,000, with the same $9,000 still owed, your ratio drops to 50%. Keeping your balance owing on each account below approximately 65% of the limit helps protect your credit score.
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3. Your borrowing power decreases with high limits
Where a higher limit on your credit cards can help boost your credit score to make further borrowing more attractive, those same higher limits can mean you qualify for less additional credit. The reason is simple: the amount of available credit you can afford to repay is limited. If you are close to this limit with the products you already have, there is less room to lend you more.
This limit, when a lender is unable to lend you more, varies. At your bank or credit union, the limit is normally 40% of your gross income. If you earn $4,200 before tax each month, that means a maximum of $1,680 can be committed to your payments. This calculation is called your Total Debt Service Ratio (TDSR) and includes your rent, your mobile phone payment if you are under contract with your service provider, the current monthly loan payments, and the minimum payment required on your credit cards.
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When some lenders calculate this ratio, they base your minimum credit card payment amount not on what you normally owe, but on your card limit. The higher the limit, the higher the (potential) minimum payment – and the less additional credit they can lend you. It can be the difference between buying the car you want and one that just gets you from A to B.
Lenders use the potential minimum payment amount because you already have that credit available to you. If you were to use it after they gave you the extra credit, you might have trouble keeping up with all your payments. Ultimately, this is for creditor protection, but it also benefits the borrower.
4. Self-control can be harder when you have more credit available
More credit available means you have more opportunity to buy things now and pay for them later. And that’s the tricky thing with credit. We all know how it works, but for many the temptation to spend what is available to them is just too great to resist. When you add in incentives like loyalty points or travel rewards and the ability to make our wishes come true instantly, it’s a recipe for debt.
You know your habits best. If lots of available credit makes you feel richer than you really are, it’s probably best to forgo a limit increase and work within what you already have.
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The bottom line on whether or not to accept a credit card limit increase offer
Many Canadians have a love-hate relationship with their credit cards. They love the convenience, security, benefits and status of their flexible friend. But a card quickly becomes an enemy when it leads to big bills, high interest charges, and tempting expenses that are hard to control. Avoid turning your lifeline into an anchor that drags you down. Only apply for and accept credit that you can reasonably manage, because as Mark Cuban once pointed out, “credit cards are the worst investment you can make.”
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Scott Hannah is president of the Credit Counseling Society, a non-profit organization. For more information on managing your money or debt, contact Scott by
or call 1-888-527-8999.
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