In the current economic pinch, there are lots of solid reasons to get your finances in order. Paying down debt balances and finding lower interest rates help to increase financial stability. It seems contrary to those goals to work on increasing your credit card limits, but doing so can improve your financial situation. Here are four ways that boosting your credit card limit can help you. (Avoid these pitfalls to keep your credit score healthy and your debt under control. See 6 Major Credit Card Mistakes.)
TUTORIAL: What To Know About Credit Cards
1. It improves your credit score.
It may seem like having lower credit limits would give you a higher credit score but, in fact, the opposite is true. A substantial portion of your credit score relates to the amount of revolving debt you have versus the limit you have available. That's because the score assumes that those who have access to credit that they haven't used can manage their credit better than those who have their credit cards maxed out. Therefore, increasing the limit on your credit cards while not increasing the balances gives your score a helping hand. If you think that you are likely to spend more if you have a higher credit card limit, however, consider whether this is the right strategy for you. Increasing your debt when you increase your limit will not improve your credit score and could even make it worse.
2. It gives you a margin of safety.
Having a credit card attached to your bank account can provide an inexpensive source of overdraft protection. If a transaction results in an overdraft, funds are automatically pulled from your card and you only have to pay the credit card interest until you made a payment on the card. In contrast, overdrawing your account with no backup payment source can result in overdraft charges of $35 to $45 for each charge plus interest. To make this strategy work, you must monitor your bank account and credit card regularly and pay your credit card as soon as you have funds in your account. Cash advances almost always incur interest from the day of funds withdrawal, so the sooner you pay it off, the less it will cost you.
3. It serves as a temporary emergency fund.
To be financially stable means having an emergency fund that would cover three to six months' worth of household expenses if an unexpected interruption of income happened. While you are building that fund, an increase in your credit card limit can provide some protection. While the goal is to not have to use up the new limit, having it available assists in paying for unexpected expenses or replacing income in the short term. It is an expensive method of financing emergencies but is far better than having no options at all.
4. It can be an inexpensive way to utilize your home's equity.
If you have equity in your house, you may be able to apply for a secured credit card. A secured card often has a much lower interest rate than a regular credit card because the balance is collateralized with your assets. This type of card is especially useful if you are undertaking house renovations. Rather than spending potentially hundreds of dollars on refinancing fees to re-mortgage your home or take out a second mortgage, you can use the secured card for renovation expenses.
TUTORIAL: How To Manage Credit And Debt
The Bottom Line
Raising the overall credit limits on your cards can give you more financing options and can lessen your financial risk. The caveat here is that you must have the willpower to not use your new limit unless it is absolutely necessary. If you raise your debt balances up to match your new limit, the benefits of the increase disappear. Managing your credit card debt wisely will pay off in both your credit report and in your financial planning goals. (The average American household has four cards, but does that mean more is better? Check out How Credit Cards Affect Your Credit Rating.)