When your bank offers to increase your credit card limit, it may seem like a good idea to have access to more money in case you need it in an emergency.
A limit increase can be a good reflection of a cardholder’s creditworthiness, but should consumers jump at the offer? Not so fast, says Ambareen Musa, the founder and chief executive of UAE price comparison site Souqalmal.com.
She says consumers should be particularly wary if their card limit was increased by the issuer without their approval being sought first.
“Think of an unsolicited credit limit increase as an upselling marketing technique employed by the bank to encourage you to spend more on the credit card,” says Ms Musa, who says having access to a higher credit limit could pull consumers “into a high-spending cycle”.
Almost one in four UAE residents consider credit card issuers the least trustworthy among financial services providers, according to April's Middle East Investment Panorama report from market intelligence consultancy Insight Discovery.
“Credit card providers have a reputational problem in the Middle East, not too surprising when their monthly interest rates are often 3 per cent and the annual percentage rate (APR) with some companies exceeds 40 per cent,” Nigel Sillitoe, the chief executive of Insight Discovery, said when the report was released.
There are 2.92 million active borrowers in the UAE and about 8 million active credit facilities, according to June data from Al Etihad Credit Bureau, which records the credit histories of the nation’s financially active residents.
While credit cards offer a convenient means of payment and help users establish a credit history, when mismanaged they can quickly become a major risk because of the effects of compound interest.
Only pay off the minimum balance each month – which equates to 5 per cent of the outstanding amount – and interest will not only be applied to the outstanding balance but also to any unpaid interest. Over time, this can cause the debt to escalate out of control.
“It's actually detrimental to hand over excess credit to borrowers who are already struggling with existing debts,” says Ms Musa. “They may not know any better than to jump at the increased credit availability, without having a game plan for how to repay any of it back.”
Increasing your credit card limit is not an altruistic gesture on the part of the bank, but a ploy to make more interest charges out of a consumer, says Steve Cronin, the founder of DeadSimpleSaving.com, an independent community for financial education in the UAE.
“If a bank increases the limit above the amount you can easily pay off in a month, then you may be tempted to not pay the full balance off each month,” he says. “This is bad for you, but great for the card company."
So how do you know if your credit limit has been increased?
Typically, the lender will send a text or email notification to the cardholder informing them of a potential credit limit increase on their card with an option to decline. However, this may happen without a cardholder's explicit request for it.
“Your credit limit can sometimes be raised automatically as a result of your positive credit history, on-time payment track record or long-term loyalty,” says Ms Musa.
Card companies have access to your credit score from the AECB in addition to having an internal score based on your accounts and other products you have with them, says Mr Cronin, explaining how banks pick their target consumers.
On some occasions, though, it may be a direct result of “overzealous mis-selling by the bank's contact centre representatives”, says Ms Musa.
Having a higher credit limit than you need will not hurt your credit score, as long you clear the balance every month. On the contrary, it can bump up your credit score by lowering your credit utilisation ratio – the percentage of the credit limit you're using up – says Ms Musa.
“With a higher credit limit and the same spending pattern as before, your credit utilisation ratio will drop, which is actually a good thing for your credit score and credit report,” she says.
Like many parts of the world, the credit scoring model used in the UAE penalises cardholders if they use up most or all of the credit available to them. Therefore the lower the credit utilisation ratio, the higher the borrower’s credit worthiness.
“If two cardholders spend the same Dh10,000 on their credit cards every month, but the first cardholder has a credit limit of Dh10,000 and the second one has a limit of Dh20,000, their credit utilisations are going to look very different – 100 per cent for the first guy and 50 per cent for the second,” says Ms Musa.
Cardholders, she adds, are often reminded to refrain from using up more than 30 per cent of their available limit, to keep their credit utilisation low.
“What tends to hurt your credit score is being right up against your limit each month,” says Mr Cronin.
According to Marwan Lutfi, chief executive of AECB, three key components can boost your score: reducing the number of credit cards you hold, consistently reducing outstanding balances and making payments on or before the due date.
"[Your credit score] is based on market data and we take into consideration things like the past due amount, the number of credit cards, the utilisation on credit limits, so for example, any negative status on these contracts, missed payments, how late these payments are," Mr Lutfi told The National in June.
Before asking for or accepting a higher credit card limit from a lender, borrowers should also weigh the possibility of sudden and unexpected changes to lending terms.
Extreme financial events, such as the Covid-19 pandemic, and systemic failure can trigger sweeping changes to lending rules. They could include banks suddenly reducing credit card limits and demanding consumers pay off balances in full.
Other triggers for banks to demand immediate and full settlement of an outstanding credit card debt can include a customer “missing three consecutive or six non-consecutive monthly payments, when the cardholder leaves the UAE permanently, and when end-of-service benefits are credited to the cardholder's bank account signalling end of employment or termination”, says Ms Musa.
Borrowers must also beware that at any point card issuers may increase your interest rate or the late payment fees arbitrarily, warns Mr Cronin.
Ultimately, it all boils down to your spending habits and current debt exposure. A credit card is not free money. The decision to accept or pass up more credit rests on “whether cardholders are in a financial position to take on more debt, and repay it back on time", says Ms Musa.
Those already struggling to meet their existing financial commitments would be better off without a larger debt. “If you don't trust yourself with a higher spending limit on your card, it may be best to have your credit limit reduced,” she says.
Some borrowers may be tempted to meet their immediate funding needs with a bigger credit card limit, but Mr Cronin insists credit cards are not for short-term cash flow management.
“This is what overdrafts and personal loans, and proper planning of your spending, are for,” he says. "The interest rate charges on cards are too high to risk not being able to pay back the extra amount quickly.”
If a limit increase on your credit card occurred without your knowledge or permission, “get in touch with the bank and place a request to bring it back to the original figure”, says Ms Musa.
However, there can be justification for accepting a bank's credit limit increase offer. “You should only accept a limit increase if you have increased income to be able to pay the balance back and increased expenses to justify the higher limit, as well as good discipline to pay off your whole balance monthly,” says Mr Cronin.