Your credit limit is set by your card issuer and determines how much you can purchase on credit each month. Ideally, you'll stay well below that number, but if you find yourself approaching that ceiling, you may start to wonder what will happen if you exceed your credit limit.
With the passage of the Credit CARD Act of 2009, creditors are no longer allowed to automatically charge you overdraft fees for spending beyond your allotted limit. In most cases, if you spend too much, your card will just get declined. If you'd like to avoid having your card declined, you can opt in to overdraft protection, though there are some drawbacks to doing so.
How overdraft protection works
If you opt in for overdraft protection and then exceed your credit limit, the transaction will still go through, but your card issuer will charge you an over-limit fee -- usually around $25 for the first offense. If you exceed your credit limit a second time within six months of the first, you'll be charged a $35 over-limit fee. The exception is if you've only exceeded the limit by a few dollars: Creditors aren't allowed to charge you over-limit fees that are larger than the amount by which you exceeded your limit.
For most people, overdraft protection isn't necessary, and it could end up costing you a lot more than $35 if you end up carrying a balance. If you're spending so much that you're unable to pay it back at the end of the month, you'll be charged interest on it. Depending on the card and your credit score, interest rates can be anywhere from 13% to 25%. If your card's interest rate is 20%, for example, and it takes you six months to pay back what you owe, that $35 fee will now cost you $42. And the more you owe, the more the effect is compounded.
Your credit score will also be negatively affected. Using most or all of your available credit indicates that you may be living beyond your means. It's not uncommon for those spending 75% or more of their monthly credit allowance to see their scores drop by 50 points or more. This can make it difficult to get loans or new credit cards in the future.
How to avoid exceeding your credit limit
The most important step you can take to avoid exceeding your credit limit is to monitor your credit usage regularly. If you know you're getting close to your limit, there are a few things you can do. The easiest option is to switch to either cash or a debit card. If this isn't possible, you can try cutting back on your spending for the rest of the month. You can also pay your credit card bill at mid-month and again at the end of the month to free yourself up to spend more.
If you find yourself regularly bumping up against your credit limit, it might be time to ask for a credit limit increase. Credit limits are determined by your credit score and your income, so if either or both of those figures is low, you may not be approved. You can apply for a credit limit increase on your card issuer's website or over the phone. You may be asked to provide updated information about your income in order to help the company make its decision.
It's important to understand what your credit limit is and to take steps not to exceed it. Be mindful of how much you're charging to your credit card and make sure you can pay the balance in full each month. If you do this, you won't have to worry about over-limit fees or having your card declined.