A lot of people wonder whether or not their income affects their credit score. The answer is a little bit more complicated than a straight “yes” or “no” since there may be indirect effects on your score and people are often asking this question as it relates to pursuing some form of credit. However, the short answer is no, your credit score is not directly affected by your income but income definitely comes into play when pursuing credit.
Credit scores explained
As I further explain in my beginner’s guide to credit scores, your credit score is determined in the following ways:
- Payment History (35%)
- Utilization (30%)
- Credit History (15%)
- New Credit (10%)
- Mixed Credit (10%)
As you can see, there’s no category where income fits in. Why is that? Well, lenders are more concerned about your ability to borrow funds and pay them back than how much money you make. Just because you make a certain amount of money, that doesn’t mean that you’ve established a track record of paying your bills on time. In fact, you might make a lot of money but have little to no experience in managing credit lines and in that case, you could pose a much higher credit risk than someone making a third of your salary but with a long payment history.
Yet, with that said, income still often indirectly affects your credit score since people with higher incomes are typically better suited to have lower utilizations, since they can access higher credit limits or more rapidly pay off debt. Also, people with higher incomes are probably less likely to miss a payment or not be able to make a payment. Since utilization is 30% of your FICO credit score and payment history is 35%, it’s often the case that people with higher incomes have better credit scores.
Although income does not directly affect your credit score, it is still a very important factor when a lender is making the decision to extend credit to you, especially when it comes to installment loans.
Specific credit scoring models
Many banks and lenders have their own type of scoring model which they use to determine your credit worthiness. These typically utilize your credit score along with other factors, such as your income, housing status, etc. So for example, a bank issuing a credit card will consider your FICO credit score but will also incorporate your stated income into its algorithms to determine if they can offer you credit and if so, how much credit you can be offered.
Some premium credit cards may have income cut-offs where below that your odds of being approved for that credit card are close to zero, but often a lower income just means a lower credit limit issued by that bank. So income is often a secondary consideration for many credit card issuers and your credit score is what is much more important.
However, for many models used to determine eligibility for installment loans, income plays a much more significant role, and one way it does that is by measuring your debt-to-income ratio.
Your debt-to-income ratio looks at how much income you have coming in each month versus how much debt you’re required to pay off each month. To find it, you divide your monthly income by your total amount of monthly debt payments (car note, student loans, minimum credit card payments, etc.). This should be distinguished from your credit card utilization (credit-to-debt ratio), as they are two completely different concepts.
Although it has nothing to do with your credit utilization, there’s a similarity between the two in that they both should be kept in check in order to maximize your chances of being approved for better credit lines and/or loans.
I recommend to keep your debt-to-income ratio between 15% and 36%. The lower the better, although it’s beneficial to have some level of installment debt so that prospective lenders can see that you can handle making payments and it also helps bump up your credit score.
Keep in mind that, subject to certain exceptions, 43% is the maximum debt-to-income ratio you can have while still meeting the requirements for a “qualified mortgage.” You can still have success with lenders even with an income-to-debt ratio over 50% but things get much tougher for you in that scenario, so try to remain much lower than that.
What specific level of income-to-debt ratio is right for you depends on what type of credit you plan on pursuing and your own comfort level with making payments for your debt. Some prefer to keep it closer to 15% to maximize savings while others may prefer levels closer to 30% so they can enjoy certain comforts, like living in a nicer loft, area, etc. You should also make sure to factor in unexpected changes to your income that could occur in the future, since that could affect your ratio significantly. (I’ll write more on this topic later since there’s plenty to cover about it.)
So when your income does matter in certain scenarios, how do banks verify your income?
The answer differs. Believe it or not, for credit card applications, it’s often the case that a bank never requires you to verify your income. (If you have a very high stated income of a few hundred thousand dollars, that might be a different story.) Every now and again, a bank may require you to submit pay stubs or bank statements for a financial review or for a credit card application, but these instances are very rare and are definitely the exception.
However, for installment loans, such as mortgages, you can guarantee that you’ll have to prove your income by submitting pay stubs or tax forms. And that makes more sense. For one, installment loans typically involve much higher sums of money so the stakes are higher. But practically speaking, an installment loan issues you a monthly bill every month that does not depend on the previous month’s spending like a credit card. Thus, it’s even more important for a lender to see that you’ll have a steady flow of funds coming in each month since you’re also guaranteed to see a steady flow of those bills coming in.
Your income does not affect your credit score, at least not directly. Having a higher income often allows you to decrease your credit utilization and that can indirectly benefit your score but there’s no category for income when determining your FICO score. On the other hand, your income often comes into play when lenders make their decision to extend your credit and for installment loans, such as mortgages, you should always expect your income to be relevant since your debt-to-income ratio is such a significant factor.