What is a credit limit and how is it determined?

Using debt financing to generate working capital or fund an expansion can be a key to success for your small business. As a startup, credit eligibility is usually dependent on your personal credit score and credit history. But 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 credit limits are determined for credit cards and small business loans. We’ll also talk about how debt affects your company’s balance sheet and how to increase business credit limits. In the final section, we’ll go over Ramp’s commerce sales-based underwriting program and how it can help your business.

What is a credit limit?

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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, set based on factors such as creditworthiness, income, and financial history. This limit helps manage the risk of over-borrowing and ensures that the borrower can feasibly repay the debt.

For secured credit, the limit is often tied to the value of collateral, such as a deposit on a secured credit card. In contrast, unsecured credit includes personal loans where limits might be determined by a borrower’s credit score and income.

A credit card’s credit limit determines how much a cardholder can spend before needing to pay off some of the balance. Each purchase reduces the available credit. When you reach this limit, further transactions are typically declined unless the issuer has provided an option to spend over the limit for a fee. As payments are made, available credit increases, allowing further use of the card.

What is 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.

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Available credit, on the other hand, is the amount you have left to borrow within that limit after deducting your outstanding balances.

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Think of it 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.

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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. Your credit limit also impacts your credit score, based on how much of your available credit you’re using at a given time.

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 your provider.

How is a credit limit determined?

Credit limits are determined by your credit card issuer or loan provider during the approval process. Your limit may be lower if it’s solely based on a 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:

Payment history

The top priority for improving your credit score and increasing your amount of credit 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.

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 your business owes to creditors, including loans, credit lines, bonds, and other forms of borrowed money.

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 DTIs at 50% or lower.

Credit utilization rate

Your credit utilization rate, aka credit utilization ratio, 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. 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 rate demonstrates responsible credit use and will boost your credit score, leading to higher limits.

Why is there a 30% credit limit rule?

Maintaining your credit utilization below 30% can positively influence your credit score. For example, if your credit card has a $5,000 limit, you should try to keep your balance no higher than $1,500. 

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But why 30%? According to John Ulzheimer, the former CEO of FICO and Equifax, "Really, being in the single digits is better." Increasingly, experts are suggesting that keeping your credit utilization below 10% is ideal—30% is the upper limit to avoid turning off lenders.

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 are my business credit score and credit limit related?

A business credit score is calculated using factors that paint a picture of your company’s credit history. These include 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 have a negative effect on 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.

What happens if I exceed my credit limit?

If you exceed your credit 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 cannot be more than $10.

Access higher credit limits based on your sales data 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, then 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 such as 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. Ramp cards also come with 1.5% cash back on purchases with no annual fee.

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