If you faithfully pay your loans, mortgage and credit cards each month, then you’ve probably received a call or letter from your bank with the news that you were pre-approved for a credit increase or a line of credit.
You might be thinking, “I don’t even use all the credit I currently have. I don’t need an increase.”
But guess what? Accepting a pre-approved credit increase may help your credit score.
Why Were You Offered a Pre-approved Increase?
If you already have an account with a bank, they may pre-approve you for a credit increase or a new line of credit, because they recognize you for being a good customer. By diligently paying off your card every month and staying on top of your current loans, your bank now trusts that you will pay them back if they increase your limit.
How Does an Increased Credit Limit Improve Your Credit Score?
No hard check
Usually, when you apply for a loan or request a credit increase, your bank sends in a request to the credit bureau for your current credit score. This is known as a hard credit check. And whenever a credit inquiry is recorded, your score is slightly affected. In the credit bureau’s eyes, applying for new credit is an indication of someone who is having financial difficulties.
However, in the case of a credit limit increase, the bank often doesn’t perform a hard credit check on your file before pre-approving you. Rather than performing a check, the bank may base their decision to give you additional credit on what they already know about you as a customer: repayment history, account balance, how much you’ve invested, etc.
As a precaution, you should still ask the bank if they intend to perform a hard credit check before accepting the increase. Some banks may claim that you’re pre-approved but still do a credit check after the fact. And even if they do plan on performing a check, this doesn’t mean you shouldn’t accept the increase. While one hard credit check won’t cause your score to fall too much, multiple inquiries at the same time could tank your score.
A decreased credit utilization ratio
Your credit utilization ratio is a key factor that plays into your credit score. It is recommended that you keep your utilization ratio within 10% to 30% of your total available credit across all your credit sources. This means that if you have $10,000 in total available credit, you shouldn’t carry a balance of more than $3,000. Spending more than 30% can affect your score – even if you pay off your balance every month.
If you have more than one source of credit, it is also better to spread the balance over each card or line of credit. For example, if you have two credit cards and each has a limit of $5,000, it’s better to have $1,000 in charges on each card than $2,000 in charges on one card.
By increasing your available credit and maintaining the same level of credit utilization, you are essentially decreasing your credit utilization ratio, which can improve your credit score.
For example, if your limit is $5,000 and you spend about $2,000 each month, you are using 40% of your available credit, which is way above the recommended ratio to keeping a good credit score.
But if you accept a pre-approved increase to $10,000, and you continue to spend $2,000 each month, you are only using 20% of your available credit, which is within the recommended ratio range.
Diversified credit portfolio
Did you know that having diverse types of credit on your record can bump up your score? Ten percent of your score is calculated based on the types of credit you use.
So, if you only have credit cards and your bank offers you a line of credit, think about accepting that offer. Having a line of credit can benefit you, and you don’t even have to use it.
You never know when you’ll need it
We often think that we can call up the bank and request a credit increase when we need it, but that’s not always the case.
For example, I once got a new job and had to buy a car within one week. To simplify the process (and earn a bunch of reward points), I planned on paying for part of the car and purchasing insurance on my credit card. However, that would’ve meant spending over 30% of my total credit. I called my bank to request a credit increase, but the time needed for approval was too long. So, I ended up paying for my car via debit and losing out on any bonus from my credit card rewards program.
Similarly, if you lose your job, having a line of credit as a back-up source of income would be a relatively inexpensive way to make ends meet. But if you’re already unemployed, you’re going to have a hard time getting approved for any new credit.
When Should You Say No to a Pre-approved Credit Increase?
Of course, there are reasons why you should say no to a credit increase. If you are in credit card debt or have a problem controlling your spending, accessing more credit is probably a bad idea. While an increased limit can potentially improve your credit score, it’s probably better to keep your available credit low to prevent further debt.
This post has been updated.