Dear Opening Credits,

How do banks know how much of a credit line to give you? I just got a credit card with a credit limit of $5,000. Last year, I got one that had a credit limit of $20,000 and they lowered it to $8,000. I was late on one payment and the card was practically empty. I don't mind having less credit because I don't even use it that much, but I still don't get how all this works. What are they looking at? 

-Michael

Dear Michael,

Why credit issuers make certain decisions can seem so mysterious. How high of a credit line you're eligible for, what interest rate they'll charge on any balance you roll over, the fees and grace periods ... it can feel so random.

But it isn't. It's a science built on proprietary formulas and company policies, which they don't have to share with you or anyone else. For example, if a bank turns you down for a credit card, all they have to do is write you a letter saying it's because of information they found on your credit report. Based on what they saw, you didn't meet their requirements. This is not illegal; it's business.

Still there are some generalities that credit issuers use to determine qualification and set terms that we do know. Here they are:

Your credit reports and score. Naturally, a credit card issuer will want to know what your borrowing and repayment history is like. Your past is an indicator of your future. Did you pay everything back as you should have, kept balances well below the charging limit and charged regularly and for more than a few years? Have you also managed installment loans and charge cards? If so, that's great. All that will work in your favor for some cards and creditors. Mind that if you didn't do all those things, other credit products may still be available to you. Some are designed especially for people who are just starting out or trying to re-establish themselves in the world of credit.

Your income. When you complete the credit card application, you will be providing quite a bit of personal and financial information. The amount you earn is a significant factor. If you have the ability to charge $50,000 overnight, but only take home $20,000 a year, the risk to the credit issuer may be too great. But if your salary is $200,000 and have few financial obligations that are eating into that income, chances are greater that you can handle such a high credit line.

So to return to your specific situation, you had a card that allowed you to charge up to $20,000. When you paid late, they dropped the credit limit to less than half that amount. No surprise there. The bank got spooked. How are they to know that it wasn't a case of you just being absentminded one month and forgetting to pay? It could have been a serious crisis that would have you running out to charge it to the max, then skipping town. They weren't punishing you, but mitigating potential loss.

And now you have a new card with an even lower charging limit. That makes sense, too, especially if you still have the account with the $8,000 limit. Most likely, that bank wanted to minimize risk. In aggregate, you might have enough charging ability as it is.

Of course, there are other factors banks consider when setting terms, including their internal matters and what's going in with the economy. But what you need to concentrate on is your own needs. As you mentioned, you don't even use the cards much. Sounds to me like you have all the credit you require.

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