Why You Should Almost Always Accept a Credit Limit Increase

Used strategically, a credit limit increase can benefit your bottom line.

On occasion, you may receive a letter from your credit card company. It may say something like, "Congratulations! Because you're a wonderful customer, we're increasing your credit limit!" Or it may say, "Congratulations! You may be eligible for a credit limit increase. To accept our offer, contact us at XXX-XXX-XXXX."

Like wedding proposals from two very different characters, you should jump on one of these offers and think long and hard about the other. Here, we'll discuss both types of letters and help you determine when it's wise to accept the big proposal.

"We're increasing your credit limit"

If your credit card company tells you "we're increasing your credit limit," that means it has already decided that it wants you to have a higher credit limit. This could be for a couple of different reasons:

1. You are an excellent customer, and the company trusts you to utilize the credit increase and pay it back as promised.
2. The company is worried that you're not that into it and wants to hold on to you as a customer.

In either case, it wants you -- it really wants you. If you look at your account online and the new credit limit has already been applied, there's nothing else you need to do.

"You may be eligible"

The word "may" tells the entire story. While acting as though you won the hog calling contest at the county fair, it doesn't actually promise you anything.

What's likely to happen is that your credit card company will run a hard credit check to make sure you're good for the higher limit. That hard credit check may have no impact on your credit score, or it could drop your overall score by a handful of points.

Let's say you tell the credit card company to go for it, it conducts a hard credit check, and your credit score drops by five points. Five points isn't much, and as long as you make all your payments on time, it won't take long for your score to rebound.

Still, imagine that your car is nearly dead and you need to purchase a new one. To qualify for the lowest possible interest rate, your favorite lender wants you to have a credit score of 740. Your score has just dropped to 735, which is quite respectable, but not high enough to score the interest rate you want.

If you receive a notification that you "may" be eligible for a credit limit increase, give the credit card company a call to learn what it plans to base its decision on. If it wants to see a copy of your last W2 or some other kind of income verification, that's easy. If it plans to run a hard credit check, make sure your credit score can withstand a slight drop.

If you can safely move forward without damage to your credit score, here are a few compelling reasons to go for the increase.

Improves your credit score

One factor that goes into determining your credit score is called the "credit utilization ratio." This ratio determines 30% of your FICO® score. Here's how it works:

Let's say that you have four credit cards, each with a credit limit of $2,500. That means that you have $10,000 in total available credit. If you owe $5,000 across those credit cards, you have a utilization ratio of 50% ($5,000 ÷ $10,000 = 0.50).

Now, imagine that one of those credit cards automatically raises your credit limit to $6,000. That means that you have $13,500 in total available credit rather than $10,000. With that credit limit increase, your credit utilization ratio drops to 37% ($5,000 ÷ $13,500 = 0.37).

The lower the utilization ratio, the better. So, a utilization ratio of 40% is better than 50%; 30% is better than 40%, etc. A credit ratio of 30% or lower is typically considered good.

Provides back-up emergency funds

An emergency fund can give you peace of mind. If things go south and you have an expensive problem on your hands, a higher credit limit means you have the option of charging any portion you don't have enough cash to cover.

Greater rewards points

No matter how many credit cards the average person carries, many of us have a favorite. For example, one person may want airline miles while another may prefer cash rebates. If your favorite credit card offers a limit increase, that gives you more opportunity to use the card for everyday expenses, pay it off in full each month, and maximize your credit card rewards.

When to say no

If you have a habit of pulling out a credit card whenever you see something you want or find yourself having to borrow from one card to pay another, a limit increase may not be in your best interest. If you routinely carry credit card debt from one month to the next and have trouble getting it paid off, it's okay to tell your credit card company thanks, but no thanks. After all, one of your jobs is to protect your financial reputation, and if an increase in your credit card limit is going to make that more difficult to do, it's fine to say no.

But if you're a bit of a pro at protecting your credit and have a plan for paying off debt, a credit limit increase is an easy, no-frills way to boost your credit score.