A credit limit is the maximum amount of
credit
Credit (from Latin verb ''credit'', meaning "one believes") is the trust which allows one party to provide money or resources to another party wherein the second party does not reimburse the first party immediately (thereby generating a debt) ...
that a
financial institution
A financial institution, sometimes called a banking institution, is a business entity that provides service as an intermediary for different types of financial monetary transactions. Broadly speaking, there are three major types of financial ins ...
or other
lender
A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property ...
extends to a
debtor
A debtor or debitor is a legal entity (legal person) that owes a debt to another entity. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor. When the counterpart of this ...
on a particular
credit card or
line of credit
A line of credit is a credit facility extended by a bank or other financial institution to a government, business or individual customer that enables the customer to draw on the facility when the customer needs funds. A financial institution ...
. Lenders generally set limits based on specific information about credit-seeking applicants, including income and employment status. Credit limits play an influential role on a consumers'
credit scores and their eligibility to obtain future credit
This limit is determined by various factors, including an individual's ability to make
interest payments, an organization's
cashflow or ability to repay the credit card debt. These factors are often summarized into a
credit score
A credit score is a numerical expression based on a level analysis of a person's credit files, to represent the creditworthiness of an individual. A credit score is primarily based on a credit report, information typically sourced from credit bu ...
, which institutions use to determine credit eligibility.
Credit limits could affect 20% to 30% of a clients credit score based on a credit utilization ratio - Percentage of
revolving credit
Revolving credit is a type of credit that does not have a fixed number of payments, in contrast to installment credit. Credit cards are an example of revolving credit used by consumers. Corporate revolving credit facilities are typically used t ...
Debt to Revolving credit available. Credit utilization ratios exceeding 30% are where negative effects on credit scores become more pronounced. Credit limit calculation is done to ensure that total
receivable exposure is consistent with the financial capabilities of the client and so a credit limit is set for each buyer. If the credit limit is lower than the theoretical credit limit, it is necessary to reduce the outstanding by negotiating better payment terms or by getting payment guarantees.
A
line of credit
A line of credit is a credit facility extended by a bank or other financial institution to a government, business or individual customer that enables the customer to draw on the facility when the customer needs funds. A financial institution ...
that has reached or exceeded its limit is considered maxed out. When maxed out, the
line of credit
A line of credit is a credit facility extended by a bank or other financial institution to a government, business or individual customer that enables the customer to draw on the facility when the customer needs funds. A financial institution ...
cannot be used for any further activity unless the
consumer
A consumer is a person or a group who intends to order, or use purchased goods, products, or services primarily for personal, social, family, household and similar needs, who is not directly related to entrepreneurial or business activities. ...
pays off at least some of the debt to enable it to fall below the limit, the
creditor
A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some propert ...
agrees to extend the limit, or the
creditor
A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some propert ...
allows one or more additional purchases with the charging of an over-the-limit fee.
References
{{DEFAULTSORT:Credit Limit
Credit card terminology