How Do Banks Set A Credit Card Limit?
Credit limit denotes the maximum spending amount that a lender agrees to give to the card holder. The limit determined annually is based on several eligibility criteria, which differ from company to company. These include the income, credit score and credit history. The limit is decided based on smooth and convenient repayment of borrowed money without suffering a debt overload.
When you apply for a new credit card, you will be required to fill in details such as
- Income details
- Employment details
- Know Your Customer essentials
All the above details help the bank to verify your credit history and score. This will help to know about your credit behavior in the past. If the score is sufficient to meet the limit set by the bank, and the report is satisfactory, the bank decides on the limit, interest rate and other conditions and terms for your card.
The criteria and policies differ based on the bank or credit card issuing company, nevertheless the information provided by the credit card holder ultimately decides the limit.
Here are two main factors that banks and credit card companies look at before setting the limit on credit cards:
1. Income and tax sourcing
When tax and income documents are used as a source for setting the limits, the card limit is based on multiplying the gross income per month to around three times. This however depends on the bank’s credit policy or on the risk the card holder is ready to take.
But the income alone is not taken into account. It is augmented by the loans you have taken and the credit report. The limit is therefore arrived at after taking into account the monthly regular expenses towards loans, EMIs and other expenses and deducting them from the gross income.
The debt to burden ration, which is arrived at by dividing all the EMIs by monthly salary, is also considered and the limit is usually a part of this ratio.
2. Sourcing on spending
In some instances banks set the limit based on the spending you do on the credit card. In other words, the limit is set on the billed amount.
If your credit card is provided based on the expenses you make such as the frequent flier benefits from an airline, or membership in a premium club, or as frequent shopper in a merchant outlet, the limit on the card will be based on the spending done annually.
If the card is issued is a co-brand card of a specific retailer, it implies that the card has been issued after considering the way you spend your money. If for instance, you spend above one lakh rupees annually at the outlet, the limit will be set based on a multiplier fixed by the merchant to deduce your income.
Even with this method, the credit history and score are taken into account to verify, if the limit set is affordable by the borrower.
Thus the limit may differ based on the documents used to get the information.
A decade ago, the credit limit had been higher than what it is now. This is because of the change in the policies set by banks. The financial crisis of 2008-2009 had forced many banks to reconsider their credit policies. They are more guarded now, when it comes to providing credit. Hence time is also a factor that influences your credit limit.
Revision of limit may be done by banks after 6 to 18 months. This is dependent on the credit policy they have set. The loan repayments and overall credit report are assessed to increase the credit limit. It is usually 1.5 times more than the present credit limit you have. This is based on the risk to revenue ratio. On the other hand, if you default on your payments the limit can be reduced too.