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Your total credit limit is the total amount you’re allowed to borrow, while your available credit is the amount of your credit limit minus your current balance on your card. It’s best to pay off your card in full each month so you will have lots of credit available. Not only does this help your credit score, but it also ensures you can use your card in case of an emergency.
When you apply for a credit card, the card issuer considers your income and credit history when deciding whether or not to approve you. When you’re approved for a card, you typically won’t just be able to charge as much as you want. The credit card issuer will set a maximum amount you can borrow. This is referred to as your credit limit. As you use your card, you’ll get closer to reaching your credit limit and your available credit will decline. Credit cards are revolving accounts, while loans are installment accounts.
It’s important to understand how credit limits work, how your available credit affects what you can borrow, and how your available credit impacts your credit score. Read on to find out everything you need to know about how credit limits and total available credit work.
What Is a Credit Limit?
Your credit limit is, quite simply, the limit of what a credit card issuer allows you to borrow. For example, a card issuer may give you a $10,000 credit limit so you won’t be able to borrow more than $10,000 on the card.
Each credit card you have will come with its own credit limit. You may have one card with a $5,000 limit and another with a $1,000 limit. The specific limit set by your card issuer will be based on how much the card provider feels comfortable allowing you to borrow.
What Is Available Credit?
Since the credit limit caps the total amount you are eligible to borrow, the amount you can currently borrow declines as you charge on your card. The amount you’re currently permitted to borrow, based on your credit limit and your current credit card balance, is called your available credit.
If you’ve borrowed $9,000 on a credit card with a $10,000 limit, you could only borrow $1,000 more before you hit your maximum limit—so your available credit is $1,000.
As you pay back your credit card, your available credit will increase. If you paid off your $9,000 balance, you’d once again have $10,000 in available credit. Your available credit matches your credit limit when your outstanding balance is $0, but as soon as you’ve charged something on the card, your available credit is lower than the limit until you’ve repaid the money you borrowed.
Why Do You Need Available Credit?
It’s important that you don’t max out your credit cards by charging up to the limit, and that you have at least some available credit. You don’t want to do this for a few key reasons.
One of the most important reasons you want some available credit is that your credit score will be adversely affected if you max out your credit cards. That’s because your credit utilization rate accounts for around 30 percent of your FICO score.
Your credit utilization rate is the amount of your credit line you’ve used divided by your total credit limit. For example, if you have charged $5,000, and your credit limit is $10,000, then your credit utilization rate is equal to 50 percent.
To earn the best credit score, your credit utilization rate shouldn’t exceed 30 percent of your credit limit. This would mean that you’d have 70 percent of your credit available at all times.
There’s also another reason why you should have available credit: you may need it for emergencies. If you’ve maxed out your credit and have a financial emergency then you could be in dire financial straits. If you have available credit, you can charge what you need to get through the emergency. If you have to put a doctor’s copay or a car repair on your card in an emergency, you’ll be very happy you had available credit.
What If You Go Over Your Available Credit?
Sometimes, when your credit card is maxed out and you’ve charged up to your limit, you may still try to use your card anyway. This would mean going over your available credit.
If you try to go over your available credit, some credit cards will deny the transaction. Others will allow the charge to go through, but you may face consequences including over-the-limit fees, a penalty interest rate, the loss of rewards, or a reduced credit line going forward.
The specifics of what happens when you go over your limit vary depending upon your cardholder agreement. You can read the terms and conditions of your card carefully to find out the rules, or ask your credit card issuer.
How to Increase Your Available Credit
You may want to have a larger credit limit on your credit card account so you can increase your available credit. If you do, you can ask your credit card issuer for an increase.
The specific process of asking for a credit limit increase varies by card issuer. You can usually request an increase online under your account tools or account services menu. Your credit card company will probably check your credit and ask for your income before determining whether to increase your credit limit.
Paying down debt will also help increase your available credit, as when your balance is low or at zero, you have lots of credit available before you hit your total credit limit. Your credit score will be better due to your low utilization rate, and you’ll have the chance to borrow if you need to, so you’ll be glad you made the effort.
Author: Jeff Gitlen
Jeff Gitlen writes about a wide range of finance topics including everything from student loans to credit cards to small business financing. Jeff’s work has been featured on a number of sites including Bloomberg, CNBC, Forbes, Market Watch, and more.