A good CIBIL score ensures that you can have an easy access to financial services in times of need. You can qualify for loans at a low rate of interest as a good CIBIL rating demonstrates that you are financially stable. There are several factors that go into the calculation of a credit score. Though different agencies have different credit scoring algorithms the major influencing factors for all of them include the payment history, credit utilization ratio, length of the credit history, type of accounts and new credit.
Credit utilization ratio has a strong correlation with the credit score. This ratio depends on two factors. Your total outstanding balance and the credit limit. A credit limit is the maximum amount that will be extended to you by the lender. You cannot charge more than that amount within a stipulated period of time. If you do not know your credit limit, you can either sign in to your credit card account to view the limit or call and ask the card company.
The credit utilization ratio is calculated by dividing the total outstanding balance on all revolving accounts with the total credit limit. For example if you have a credit limit of Rs 3,00,000 and your outstanding balance at the end of the month is Rs 2,40,000, your credit utilization ratio is 2,40,000/3,00,000 i.e 0.80. This means that you are using 80% of the available credit. This high ratio is a strong warning sign of credit risk. It indicates that either you are living beyond your means or you are experiencing financial difficulty. Your profile is considered risky as you may have trouble making future payments. Hence a high utilization will bring your credit score down. If your outstanding balance is only Rs 30,000 then the ratio will be 30,000/3,00,00 i.e 0.10. A low utilization ratio is a sign of financial soundness as you are not using too much of available credit. This works in favour of the credit score. Hence the credit card limit directly affects the credit utilization ratio and therefore the credit score of an individual.
Does a low credit limit translate into a low score?
If you have a low credit limit, it does not necessarily mean that you will have a low credit score. If you pay your credit cards in full each month before the due date and do not carry any balances your credit utilization ratio will be zero. In this case the amount of credit limit will not have any effect on the score. It is always a good idea to keep the credit card balance as low as possible in relation to the total credit limit. If you do so you can keep the overall credit picture healthy even if your limit is not too high.
Should you request for a credit limit increase to raise your score?
If you are looking to improve credit score, then a higher credit limit will definitely be a good thing. You can either request your current credit card company to raise your limit or apply for a new credit card. Even if the amount owed by you remains the same, a high limit will result in a lower debt utilization. It is suggested to keep the utilization below 30% if you are trying to improve credit score.
When a card company extends your credit limit it increases the amount of debt you can incur and gives you greater buying power. Just make sure that a high limit does not tempt you to increase your spending, otherwise the whole purpose of getting the limit increased will be defeated. Take into account your saving goals and exercise financial discipline. Use the limit only when you really need it. If you are not careful you will carry more balances each month and that will translate into paying more interest to the card company.
Will closing a credit card account affect my credit score?
It is never a good decision to close old unused credit cards just for the sake of cleaning up your credit profile as far as credit score is concerned. That’s because closing a card will reduce your total credit limit available and increase your credit utilization ratio.
Your credit card limit surely has an effect on the credit score. But it is only one piece of the puzzle. If you are trying to improve credit score it is necessary to look at the bigger picture. Paying down outstanding balances and maintaining a clean track record of on time payments also go a long way in enhancing your score.