One of the keys to managing your credit is understanding the role your credit score plays in determining your credit limit and vice versa.
Behind Credit Limits
Credit card companies decide your credit limit through underwriting, a process of considerable testing and analysis used to determine who to approve, at what rate and at what credit limit. Underwriting details are guarded company secrets because they impact how a company makes money. Due to this, it's hard for consumers to get more than a limited understanding of how credit limits are determined.
To shed some light on the relationship between credit scores and credit limits, Credit Karma sampled approximately 15 million Credit Karma members who visited the site in 2014, and compared their credit limits with their credit scores.
The graph above suggests that there is a significant correlation between consumers having a higher credit score and having higher credit limits. This makes sense when we consider the fact that your credit score is meant to be an indicator of your default or delinquency risk and overall credit management. Using credit score and other credit report information, a credit card company can estimate whether an increase in your credit limit could provide an additional revenue opportunity for them or whether a credit line reduction is necessary to reduce their risk for losses.
How does this work in practice?
Say, for example, consumers with a "fair" credit score may have an expected default rate of 10 percent*, meaning the expected loss on a $1,000 credit limit would be $100. On the other hand, consumers with an "excellent" credit score may have an expected default rate of one percent*, meaning the expected loss on a $1,000 credit limit would be $10. In this scenario, assuming the expected revenue from each of the consumers is similar, an "excellent" credit score cardholder is more likely to be approved for a higher credit limit, thanks to their better credit profile.
The influence credit scores have on credit limits works in a feedback loop, but other credit report factors can come into play in determining each. Other factors such as payment history, credit utilization, types of credit and changes in spending patterns can also contribute to an increase or decrease in credit scores or credit limits.
*Example rates are for illustration purposes only.
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