What is a credit limit and how is it determined?

What is a credit limit?

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Using debt financing to generate working capital or fund an expansion can be key to your success as a small business. As a startup, credit eligibility usually depends on your personal credit score and credit history. If you’re a more established business, you may have a business credit rating from a credit bureau like Dunn & Bradstreet or Experian Business.

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In this article, we’ll review how lenders determine credit limits for credit cards and small business loans. We’ll also cover how debt affects your company’s credit score and how to increase your business credit limits.

‍How is a credit limit determined?

Your credit card issuer or loan provider determines your credit limit during the approval process. For secured credit, the limit is often tied to the value of collateral, such as a deposit on a secured credit card. In contrast, with unsecured credit, your limit might be determined by your personal credit score and income.

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Your limit may be lower if it’s solely based on your personal FICO score, while higher revenue and a business credit score will typically give you access to a higher limit.

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Here are four factors that determine your credit limit:

1. Payment history

The number one factor for improving your credit score and increasing your credit limit is to consistently make full, on-time payments. Providers may give you a lower credit limit if you fall behind on payments or if you regularly exceed your credit limit.

2. Total debt

‍Lenders want to know how much you as a company or an individual already owe to other lenders before they approve you for more funding. Total debt refers to the combined amount of all outstanding debts and financial obligations that you or your business owe to creditors, including loans, credit lines, bonds, and other borrowed money.

3. Debt-to-income ratio

While the amount of debt you owe is a determining factor, what’s more important is your debt-to-income ratio (DTI). That’s your monthly debt payments divided by your gross monthly income. If your business income is significantly higher than what you owe, you may be approved for a credit limit increase. Lenders like to see your DTI at 50% or lower.

4. Credit utilization ratio

Your credit utilization ratio, also known as your credit utilization rate, refers to the size of your balance compared to your credit limit. To calculate it, divide your outstanding credit card balances by your total credit card limits.

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For example, if you have $2,000 in credit card debt and a total credit limit of $10,000, your credit utilization rate would be 20%. A lower credit utilization ratio demonstrates responsible credit use and will boost your credit score, leading to higher limits.

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How does a credit limit work?

A credit limit is the maximum amount a financial institution allows a borrower to access. Credit limits help manage the risk of over-borrowing and ensure that the borrower can feasibly repay their debt.

A credit card’s credit limit determines how much a cardholder can spend before they need to pay off some of the balance. Each purchase reduces the available credit

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When you reach your limit, further transactions are typically declined unless the issuer has provided an option to spend over the limit for a fee. As you make payments, available credit increases, allowing further use of the card.

What’s the difference between a credit limit and available credit?

Your credit limit is the maximum amount a lender allows you to borrow on a credit card or line of credit. It's like your spending cap. Available credit, on the other hand, is the amount you have left to borrow after deducting your outstanding balances against your credit limit.

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Think of available credit as the remaining balance on your credit card or credit line that you can still use without going over your limit. Tracking both your credit limit and available credit is crucial to managing your finances responsibly and avoiding over-borrowing.

What’s a good credit limit to have?

Ideally, your credit card limit should be high enough that you can use the card for necessary expenses while keeping your credit utilization ratio low—at least around 30%, but ideally lower. Credit limits for small businesses tend to be higher than personal credit limits. The average business credit card limit in the US is $56,100, but your limit may differ from national averages. That’s because a lot of data goes into calculating your business’s credit limit.

What happens if you exceed your credit limit?

If you exceed your credit card limit, your card will typically be declined. If the transaction is approved, you may be subject to over-the-limit fees. This fee is usually a maximum of $35, but it can’t surpass the amount you go over your limit. For example, if you exceed your limit by $10, the fee can’t be more than $10.

Why did your credit limit change?

Your credit card issuer might change your credit limit based on your spending habits. If you've missed payments, rarely used the card, or taken on debt, your issuer might decrease your limit. Conversely, if you consistently pay on time, use your credit card often, and your credit score improves, you may get a higher credit limit.

How can you check your credit limit?

You can usually find your credit limit in your online account and on your credit card statement. If you're unsure, you can also call the phone number on your credit card to check with the issuer.

Why does a credit limit matter?

A credit limit matters because it determines the maximum amount of money you can use to cover expenses. It’s important to be aware of your credit limit before making purchases so you can avoid exceeding it and facing additional charges.

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Your credit limit also impacts your credit score based on your credit utilization rate—how much of your available credit you’re using at any given time. To build or maintain a strong credit score, you should keep your credit utilization as low as possible—below 30%, but ideally even lower.

How are my business credit score and credit limit related?

Your business credit score is calculated based on factors like your payment history, late payments, total revenue, and debt-to-income ratio. When lenders see a high business credit score, they’ll consider giving you a higher credit limit on new loans. Credit card companies may also offer better credit card rewards and more competitive interest rates for higher scores.

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On the flip side, missed or late payments will hurt your credit report. You can avoid missing payments by investing in small business accounting software to keep track of cash inflows and outflows. Ramp connects to several accounting platforms, including QuickBooks, and we help you track business expenses so you can stay organized.

Access higher credit limits based on your revenue with Ramp

At Ramp, we’re committed to helping small businesses access the funds they need to accelerate their growth. As a startup, traditional lenders may not approve you for a loan because your revenue is too low or your company hasn’t been in business long enough. But if you have ecommerce sales revenue coming in, Ramp’s sales-based underwriting can help you out.

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Ramp can offer a credit limit up to 30 times higher than our competitors. That’s because we use our connections to some of the biggest commerce platforms, web stores, and marketplaces in the industry, including Stripe, Shopify, and Amazon, to underwrite credit limits for businesses using their commerce sales data. To qualify, all you need is one year of sales data.

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Learn more about Ramp’s commerce sales-based underwriting.