Reviewed by Aug 27, 2020| Updated on
What Is a Credit Limit?
The term credit limit applies to the maximum credit amount allocated to a customer as extended by a financial institution. A lending institution applies a credit limit to either a credit card or any credit line. Lenders usually set credit limits in the application of the person seeking credit, based on the information provided.
Understanding Credit Limits
A credit limit is a factor determined based on consumers' credit scores and can impact their ability to get credit in the future. The limits are set by banks, alternative lenders, and credit card companies based on multiple pieces of borrower-related information. They examine the credit rating of the borrower, personal income, history of repaying loans, and other factors.
Both unsecured credit and secured credit limits can be set. Usually, unsecured credit involves credit cards and unsecured credit lines. If the credit line is secured — backed by collateral— the lender will take into account the value of the collateral. Say, someone takes out a credit line of home equity; the credit limit varies based on the borrower's home equity.
How Do Credit Limits Work?
A credit limit works the same way no matter whether the borrower has a credit card or a credit line. A borrower can spend up to the credit limit. If that amount is surpassed, he will normally face fines or penalties in addition to their regular payment. If the borrower spends less than the threshold, he may continue to use the credit card or line until he reaches the limit. High credit limits may be troublesome, as overspending may make repayments difficult.