Credit Limit

A credit limit is the maximum amount of credit an issuer makes available on a revolving account, most commonly a credit card. It is the defining feature of revolving credit as distinct from an installment loan. An installment loan has a balance that only goes down, while a revolving account has a limit and restores available credit as the balance is repaid, so the amount that can be borrowed refills rather than running out.

Two related figures get used interchangeably and should not be. The credit limit is the ceiling set in the account agreement. Available credit is what is left of it right now, after the current balance and after any pending authorizations a merchant has placed but not yet settled, which is why a card can decline at a point that looks well inside the limit. A hotel or fuel authorization can hold several hundred dollars of the line for days after the transaction itself.

A limit also feeds the ratio of reported balances to credit limits that scoring models call credit utilization. That relationship runs one way and is covered where it belongs, on the page for the ratio itself. What this page covers is where the limit comes from and what happens at the edge of it.

Federal law regulates how a limit is set, and almost no consumer page mentions it. 12 CFR 1026.51(a)(1)(i) provides that a card issuer must not open a credit card account for a consumer under an open-end, not home-secured, consumer credit plan, or increase any credit limit applicable to such account, unless the issuer considers the consumer's ability to make the required minimum periodic payments under the terms of the account based on the consumer's income or assets and the consumer's current obligations. The regulation then requires written policies and procedures, and adds a sentence with real bite: it would be unreasonable for an issuer not to review any information about a consumer's income or assets and current obligations, or to issue a credit card to a consumer who does not have any income or assets.

Note that the rule reaches increases as well as openings. That is the reason a request for a higher limit comes back with a question about income, on an account the issuer has watched behave perfectly for a decade. The issuer is not being obstructive; it cannot lawfully raise the limit on ability-to-pay grounds it has not considered.

The safe-harbour assumption explains why an approved limit is often smaller than the applicant expected. 1026.51(a)(2) lets an issuer satisfy the rule by using a specified method for estimating the minimum payments, and (a)(2)(ii)(A) requires that the issuer assume utilization, from the first day of the billing cycle, of the full credit line that the issuer is considering offering. In other words the underwriting has to be done as though the applicant maxes the card out immediately and starts making minimum payments on the whole thing. A larger line is therefore a larger assumed obligation, and the limit an issuer will approve is bounded by the minimum payment the applicant could carry on a fully drawn account, not on the balance they intend to run.

A separate set of rules applies to applicants under 21. 1026.51(b) provides that an issuer may not open an account for a consumer under 21 unless the consumer has submitted a written application and the issuer has either financial information showing an independent ability to make the required minimum payments, or a signed agreement from a cosigner, guarantor or joint applicant aged at least 21 who has that ability. Where an account was opened on the young consumer's own financial information, the limit generally cannot be increased before they turn 21 unless they independently qualify.

The over-limit regime is a live consumer right, and the everyday behaviour most people experience is the default rather than a courtesy. 12 CFR 1026.56(b)(1) prohibits an issuer from charging a fee for an over-the-limit transaction unless it has given a segregated notice describing the right to opt in, provided a reasonable opportunity to consent, obtained affirmative consent, confirmed that consent in writing, and disclosed the right to revoke it. And (b)(2) is the part worth knowing: notwithstanding the absence of consent, the issuer may pay the over-limit transaction anyway, provided it imposes no fee for doing so. So a card that quietly declines at the limit, or goes through without a charge, is the regulation working as designed.

Even after an opt-in the fees are bounded. 1026.56(j)(1)(i) permits no more than one over-the-limit fee per billing cycle, and only if the limit was actually exceeded during that cycle, and bars charging for more than three billing cycles for the same over-limit transaction where the balance has not been brought back under the limit by the due date for either of the last two cycles. An issuer also may not charge an over-limit fee merely because it was slow to restore available credit after crediting a payment. Consent can be revoked at any time by the method the notice describes, and the issuer must act on the revocation as soon as reasonably practicable.

One consequence of a limit is worth naming even though its depth belongs elsewhere. A limit decrease raises credit utilization without anyone spending anything, because the ratio's denominator has shrunk. Issuers may reduce limits on inactive accounts or in a general tightening, and a cardholder who never changed their behaviour can find the ratio has moved against them. The ratio and its effect on a score are covered on the credit utilization page.

At application the issuer pulls a credit report, considers income or assets and current obligations, and estimates the minimum payment the applicant would face on the line it is contemplating. If that payment looks supportable, the line is approved at that size. The same test runs again on any later increase, whether the cardholder asks for it or the issuer offers it. Between times, the issuer may reduce the limit, and the account agreement will say so.

A hypothetical example of the safe-harbour assumption in action. Suppose an issuer's minimum payment formula for a particular card is 2% of the balance, which is an assumption of this example rather than an industry figure, since formulas are set by each issuer. Ana applies and the issuer is considering a $20,000 line.

The rule does not let the issuer test Ana against the balance she says she will carry. It must assume the full line is drawn from the first day of the billing cycle, so the minimum payment it has to find supportable is $400 a month ($20,000 × 0.02), before any interest or mandatory fees the formula adds on top. If Ana had told the issuer she planned to keep about $3,000 on the card, the payment implied by that balance would be $60 ($3,000 × 0.02), which is not the number the regulation asks about.

So the size of the line Ana is offered depends on whether her income and obligations can support a payment on a maxed-out card, and that is why an applicant with a solid file and a modest income is routinely approved for a smaller limit than they expected. It also explains the shape of the remedy. Limits typically rise over time as income rises and the issuer refreshes what it knows, rather than as a reward for good behaviour alone.

Pros

• A limit caps the exposure. Unlike an installment loan, the maximum liability on the account is knowable in advance and stated in the agreement.
• The ability-to-pay rule means the number reflects a documented view of whether the payments are supportable, rather than the issuer's appetite alone.
• Available credit refills as the balance is repaid, which makes a card useful for recurring short-term needs without reapplying.
• Over-limit fees require an affirmative opt-in, so the default outcome at the limit costs nothing.

Cons

• A higher limit is easier to spend into, and nothing about the approval is a statement that carrying the balance would be affordable.
• Issuers can cut a limit with notice under the account agreement, which raises credit utilization without any change in behaviour.
• Available credit is not the same as the limit, so pending authorizations can cause a decline that looks inexplicable.
• Requesting an increase generally means giving the issuer updated income information and may involve a credit inquiry.
• Opting in to over-limit coverage exposes the account to a fee that would otherwise be legally impossible.