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? Turning down a pre-approved credit increase may actually hurt your credit score.
Why you were offered an increase
If you already have an account with a bank, and it pre-approves you for a credit increase or new line of credit, it’s typically because you are being recognized 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 increased your limit.
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How an increased credit limit can 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, the bank often doesn’t perform a hard credit check on your file before pre-approving you. Rather than performing a check, the bank’s decision to give you additional credit is typically based 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 on performing 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 really tank your score.
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 20 per cent of your total available credit across all of your credit sources. This means that if you have $10,000 in total available credit, you shouldn’t carry a balance of more than $2,000. Spending more than 10 to 20 per cent 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 per cent 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 per cent 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 per cent 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 just 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 the span of one week. In an attempt 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 per cent of my total credit. I called my bank to request a credit increase, but the time needed for an approval was too long, so I ended up paying for my car via debit.
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 type of new credit.
When to say no
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, giving yourself more credit is probably not a good idea. While an increased limit can potentially improve your credit score, it’s probably better to keep your available credit low if it prevents you from going into further debt.
This post has been updated.