Here’s How Salary and Income Affect Your Credit Score
While your salary and income are not listed on your credit report, they may have an indirect effect on your credit score. They’re also used by lenders to determine the likelihood that you’ll be able to pay back the money you borrow. It’s important to understand the relationship between debt and income so you can maintain a good credit score and show lenders that you’re not at high risk of defaulting on your loans.
What’s the difference between salary and income?
Though we often use the words interchangeably, salary and income are not the same thing. Your salary is the compensation you earn from working, or what is reported on a W-2 form to the Internal Revenue Service by your employer at the end of each year. On the other hand, your income — which includes your salary — is revenue that comes from any number of sources. Social Security benefits, stocks, rent payments, child support and alimony all count as part of your income.
Do your salary and income affect your credit score?
Salary and income do not appear on credit reports, so they do not directly affect credit scores. However, having insufficient or unpredictable income can place you in greater jeopardy of not being able to pay your bills. Regardless of how much money you take home every year, be mindful of the relationship between what you earn and what you spend to avoid falling into the bad credit trap.
Your income can influence credit applications
Though your income doesn’t affect your credit score, it will be a direct factor when you apply for a credit card. Thanks to the 2009 Credit Card Accountability Responsibility and Disclosure Act (CARD), a law that was intended to curb deceptive practices among credit card companies, issuers must inquire whether you have access to enough income to cover your line of credit. “Different card issuers have different standards for creditworthiness,” said Nathan Grant, a Syracuse, N.Y.-based credit industry analyst with Credit Card Insider. “They use your income to determine things such as the amounts of your initial credit limit and subsequent increases.”
Another figure lenders consider is your debt-to-income (DTI) ratio. This is a formula that compares your pre-tax income to the amount of debt you currently pay out monthly. It doesn’t factor into your credit score, but it does affect your chances of approval for loans with large amounts. When lenders make the decision to let you borrow money, they use self-reported income from loan applications to calculate the ratio.
For mortgages, the maximum acceptable DTI ratio is usually 43%. However, credit bureaus and companies that extend credit typically do not like seeing a DTI ratio that is higher than 30%, said Henry Wong, the Tucson, Ariz.-based founder of Friendly 401k. “While your DTI does not have a direct correlation to your credit score, credit companies will often be wary of extending further credit to an individual with a high ratio. These companies reason that the individual will have a higher likelihood to be overcome with debt and therefore unable to fulfill their payment obligations.”
What can you do to improve your debt-to-income ratio?
You can improve your DTI ratio in one of two ways, said Kevin Haney, New York-based founder of A.S.K. Benefit Solutions. “Either lower the numerator, which is your monthly debt payment, or boost the denominator, which is your monthly income.” Here are some steps you can take:
Pay down outstanding debt. Try paying off your smallest installment contract in full, refinancing large installment loans or paying down high-interest credit card balances, Haney suggested. This will not only reduce your DTI but will save you money on interest fees.
Don’t buy what you can’t pay for. The temptation to load up your credit card with purchases you can worry about “later” is rarely a good formula for financial well-being. “Credit card debt is meant to be revolving or paid off in a short period of time,” said Corey Vandenberg, a mortgage consultant with Platinum Home Mortgage in Lafayette, Ind. “Instead, along with auto loans, this has become a very expensive, never-ending debt for most people — I’ve seen it as high or higher than a mortgage payment.” A good rule of thumb is, if you won’t be able to pay for it when the bill comes, then don’t put it on your credit card.
Increase your monthly income. Obviously we’d all like to make more money, and finding a job with a higher salary isn’t always an option. But consider boosting your income with some side gigs, or talk to your employer about setting a timetable for a raise. “If someone has been working with a company for a long enough time, I will encourage them to ask for a raise during the next annual employee review,” said Wong.
Add an additional party to your loan application Your cosigner should have an equal or higher income than you to increase your stated “income” on the application, said Nathalie Noisette, founder of Avon, Mass.-based Credit Conversion. “This is usually an individual who will be equally responsible for the loan, such as a spouse or parent.”
While your salary and income are not listed on the credit reports issued by the three major credit bureaus, they are important variables in the success of your application for a loan or credit. And they are an important part of your overall financial profile. The thing to remember is, you should never take on debt without considering how much of your income it will take to pay it off. Lenders are looking at that relationship, so you need to be, too.