Should You Accept a Pre-Approved Credit Limit Increase?

Pre-Approved Credit Limit

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Occasionally, you may receive a letter from your bank informing you that you’ve been pre-approved for a credit limit increase. The offer is typically for your credit card or line of credit. Or, if you don’t have a line of credit, your bank provides you with the opportunity to open an account.

We don’t blame you if your first thought is, “That’s great news! Now I can boost my spending power.” Who doesn’t want access to more credit, right?

However, should you accept a pre-approved credit limit increase each time your bank or other lender offers one? In short, the answer is “maybe.” Depending on your spending habits, current debt load, income, and other factors, a credit limit increase may be a blessing or a curse.

In this article, we’ll explore what a credit limit increase means, the pros and cons of accepting one, its impact on your credit score, and what to consider before deciding to either welcome the offer or decline it.

How a pre-approved credit limit increase works

A credit pre-approval doesn’t guarantee you’ll receive a credit limit raise. Should you accept the offer, your lender may still need to perform a hard credit check on your credit report. This means they’ll dig deeper into your credit history to ensure you meet all their eligibility criteria. If you don’t satisfy the requirements, you won’t get approved for the increase.

Advantages of accepting a credit limit increase

Here are some of the benefits of having access to more credit:

Greater spending power

With more funds at your disposal, you can help pay for expensive purchases, such as a vacation or Christmas shopping for your family. You can also use the extra credit room to finance a home renovation, college program, and other pricey endeavours.

Access to emergency funds

A generous credit limit can cover a cash shortfall when a financial emergency arises. You never know when you’ll run into a giant, unexpected medical bill, tax bill, car repair bill, etc. And turning to your credit card or line of credit is a cheaper option compared to a payday loan or other high-interest debt product.

More rewards points

Do you love collecting air miles, cashback, or other reward points on your credit card? If so, a credit limit increase will enable you to garner even more to redeem on your favourite items convert to cash.

Lower credit utilization ratio

Credit utilization is a financial metric that measures how much of your available credit you use relative to your credit limit. It’s one of several factors that credit bureaus use to determine your credit score

An increase in your borrowing power can lower your credit utilization ratio, which can, in turn, boost your credit score. The reason is that the more credit you use, the more likely you are to default on your balance. Most lenders prefer to issue loans to borrowers whose credit utilization is no more than 30%.

To illustrate, let’s say your credit card’s current credit limit is $5,000, and your balance owing is $2,500. In this case, your credit utilization is 50% ($5,000 / $2,500).

Let’s say your credit limit rises to $7,500. In turn, your credit utilization would automatically drop to 33% ($7,500 / $2,500). That’s a significant improvement that can positively impact your credit score.

More funds available for investing

A new line of credit account can replace your emergency savings account, allowing you to diversify your investments. When you need quick access to cash, you can draw from your line of credit instead of your savings account.

Suppose you hold some money in a savings account strictly for emergency use. In that case, you can divert the funds to stocks, bonds, GICs, or other assets to earn a higher return. 

Disadvantages of accepting a credit limit increase

Just as there are benefits to raising your credit limit, there are also drawbacks to be aware of.

Potential to get heavily into debt

A higher credit limit can tempt you into spending far more than your budget can justify. Eventually, your balance can grow so large that repaying it can become challenging. 

Credit cards and lines of credit only require you to make a minimum payment each month to keep your account in good standing. And this amount is typically a tiny fraction of the total amount you borrow. The flexible payment terms encourage overspending and deferring payment of the principal into the future. 

Loss of access to other loans

Let’s say you rack up huge balances on your credit cards and lines of credit. In that case, you may face more hurdles in obtaining other types of financing. These can include a mortgage or car loan. 

Lenders review your credit report each time you apply for a loan. If they see you currently carry a lot of debt, they may view you as a high-risk borrower, meaning you could default on your payments. As a result, they’ll be less inclined to approve your application. 

Unexpected interest rate hikes

The interest rate you pay on a line of credit is variable. This feature means your rate can move up or down based on changes in your lender’s prime rate. Should your lender’s prime rate rise, so will the rate you pay on your line of credit, which means you can expect a higher monthly payment.

Interest rates on credit cards are more stable. However, if you fail to pay your minimum payment on time, your card issuer can raise the rate they charge you. This interest rate is called the penalty APR, which can be 30% or more.

The balance owing is callable

A line of credit is a callable debt product. This means that your lender can demand that you repay the entire balance at any time. 

If your lender believes you’re struggling financially, the risk that you won’t repay the loan rises. To counter this risk, they can alter the payment conditions and require you to pay more than usual each month or pay off the loan immediately. This change can put a massive strain on your budget.

Expensive emergency fund

Many say that “cash is king,” – and they’d be correct when referring to an emergency fund. Some financial experts believe that cash emergency funds are obsolete, given the availability of revolving debt products like lines of credit.

However, they neglect to mention that borrowing through a line of credit during a crisis isn’t free, as you must pay interest on your balance. And the interest expense can be considerable if you borrow a huge sum of money, especially in a high-interest rate environment.

On the other hand, drawing cash from your emergency savings account costs you nothing in interest charges.

How does a credit limit increase affect your credit score?

For the most, a credit limit increase will have a positive impact on our credit score. The primary reason is that a higher credit limit decreases your credit utilization ratio, which we discussed previously. 

Credit utilization accounts for 30% of your total credit score. So, a significant increase or decrease in your credit limit can move it up and down, respectively. As your lender raises your credit limit, your credit utilization drops, which can bump up your credit score.

Your credit mix is another factor that affects your credit score, but to a lesser degree (about 10% of your total score). Credit mix refers to the diversity of your debt. When reviewing loan applications, lenders view favourably a credit report with a good mix of the following: 

  • Revolving credit – credit cards and lines of credit
  • Installment loans – car loan, student loan, personal loan, mortgage
  • Open account – phone plan, internet plan

A broader mix of loans on your credit reports indicates that you have extensive experience managing debt. Thus, raising your credit limit if you have primarily installment loans can improve your credit score. Of course, the opposite is also true.

Another way a credit limit increase can affect your credit score is through the hard inquiry your lender performs on your credit report. 

Each hard credit check impairs your credit score temporarily and can remain on your credit report for three years. However, the effect on your credit score is minimal and lasts only one year generally. A hard credit check constitutes about 10% of your overall credit score.

What to consider before accepting or declining a credit limit increase

Still not sure whether to accept a pre-approved credit limit increase from your lender? Here’s some criteria to help you decide:

Reasons to accept a credit limit increaseReasons to decline a credit limit increase
You follow a strict budget or live a frugal lifestyleYou tend to overspend and don’t follow any budget
You always make timely loan paymentsYou frequently miss loan payment deadlines
You pay your balance owing in full each monthYou typically only make partial payments or the minimum payment each month
You occasionally exceed your credit limit and need an extra cushion to prevent being charged over limit fees or having your transactions declinedYou often exceed your credit limit, usually through impulse buying
You plan to use the extra spending power to finance a home renovation, attend college or pursue another worthwhile endeavour that can improve your financial standingYou use your credit to fund living expenses and leisure activities
Your current debt payments are manageableYou’re already heavily in debt
You’ve received a raise at work or started a new higher-paying jobYour income has declined
You have enough spare cash to pay down your balance quicklyYou have little disposable income and can only repay your balance slowly

Saying “yes” to a pre-approved credit limit increase can enhance your financial standing. But this is only true if you carry little debt, make your payments on time, follow a budget, and spend your money wisely. If this describes you, recurring spending power boosts will serve you well.

However, with too much credit at your disposal, it’s still easy to get caught up in a spending cycle. And when that time comes to begin repaying your principal, you may lack the funds needed to settle your balance.

If you’re struggling financially and looking for debt relief, the sooner you take action to tackle your loans, the better. You may wish to consider speaking with a Licensed Insolvency Trustee to explore your options for reducing or eliminating your debt.

A Licensed Insolvency Trustee is the only professional in Canada who can carry out government-regulated insolvency programs on your behalf. One of these is a consumer proposal, which can help you eliminate up to 80% of your unsecured debt, leaving you with a much smaller balance to repay. See how much you can save using our debt calculator.

Photo by Mikhail Nilov

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