Here’s why no preset spending limit credit cards aren’t what they seem…
A couple decades ago, American Express was the first credit card company to offer no preset spending limits on their charge cards. Over the past several years, more and more cards have adopted this feature (Visa Signature & World MasterCard). But here are some things about them you need to know…
No preset limit does not mean no credit limit!
Please be aware that so-called “no limit” credit cards do have a spending limit! They just don’t have an upfront, stated “preset” limit – that means each purchase is approved or denied on a case-by-case basis and is dynamically adjusted on a daily basis depending on things like like your credit recent credit behavior, spending patterns, debt to income levels and other ever-changing risk factors.
If you attempt to go beyond your normal spending patterns you may find your purchases being denied. For example, if you typically charge $2,500 per month on your no preset limit credit card and then one month you try to spend $5000, you may quickly find that all purchases beyond 10% of normal (say $2,750) will get denied at the point of sale. This is called a shadow limit in banking parlance and gives cardmembers a buffer of sorts beyond their rolling average. But if you plan to make any big purchases on any given month you may want to give your bank a call to give them a heads up.
With no credit limit being pre-defined, your credit score may be negatively affected
On revolving credit accounts (i.e. credit cards) the FICO scoring algorithm takes into account what percentage of the credit limit is being used. Using a high percentage on even one account is actually a bad thing. Typically you never want to use more than 30% (and under 15% would be even better).
Unfortunately, for a credit card with no defined limit, issues can arise when computing the credit utilization ratio of that account. Below is a letter from FIA Card Services (Bank of America) which explains why…
If your highest historical balance was several times higher than your monthly balance, then this shouldn’t be a problem. But if you typically spend $1,500 per month and your highest historical balance was $3k, that would equal out to be 50% credit utilization in the scenario described above.
This is a definite drawback with no preset limit credit cards.
Banks love no preset spending limits
Obviously, the perceived notion of a “no limit credit card” sounds very customer-friendly and is good for marketing, but that’s not the real reason banks offer cards with these terms…
A no preset limit credit card is an important risk-management tool for the issuing bank. Since the credit limit is not disclosed to the customer, it can be adjusted at anytime with the customer never knowing. This means there’s no need for those troublesome letters saying an account’s limit has been reduced, and hence, there is no customer backlash or any requirement for the customer to opt-in to the new terms with a 45 prenotification requirement, as would be required otherwise.
This is why you are seeing more and more World MasterCard and Visa Signature cards. In fact, due to the financial meltdown experienced following the near collapse of the US economy during the last decade, the vast majority of cards on the market will probably have no preset credit limit by 2020.
Should you consider a card with a no preset limit?
There are so many great reward credit cards that have no preset limit, it’s pretty difficult to avoid them if you want to get the most bang for your buck. They should pose no problem if you know what you’re doing.
What I have done with my own no preset limit credit cards is make a large purchase on each that is approximately 700% higher than my average monthly spending. I then return those purchases during the next billing cycle. That way my highest historical balance is about 7x higher than what I will probably be spending during any given month (which means a maximum 15% utilization rate on each of those accounts).
Conclusion: Remember, a no limit credit card does in fact, have a spending limit. Manage them the right way and they shouldn’t be a problem.
Written or last edited on August 31, 2015