How Do Credit Limits Work?


Quick Answer

A credit limit is the maximum sum an account holder can charge within a billing cycle, according to Fox Business. If the account holder makes any charges during the cycle, he receives a statement showing the balance and the minimum monthly payment required to satisfy the account terms. Until the account holder pays the full balance, the amount he can charge decreases, equaling the original credit limit minus the amount spent and any accumulated finance fees.

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Full Answer

Individual lenders decide how much credit they are willing to extend, based on factors such as a borrower's credit score, repayment history and debt-to-income ratio, U.S. News & World Report states. Regardless of an account holder’s starting limit, borrowing habits can have a positive or negative impact on future credit because creditors re-evaluate accounts roughly every six months. Borrowers who were originally considered a credit risk may receive a limit increase if they make minimum payments on time and keep total credit utilization under 30 percent. On the other hand, borrowers with a higher limit may receive a reduction if they show a pattern of delinquency.

Covering only the minimum payment on a high account balance is a potential pitfall of using credit, notes Fox Business. Creditors charge finance fees for every cycle in which the account carries a balance. If the balance is close to the credit limit, the escalating fees make the payoff period longer, especially if the account holder only applies small payments.

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