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One of the most common credit score questions is if your income plays into having a great or not-so-great score. The short answer is no, you can have a great credit score no matter what your paycheck is. The five main factors that comprise your credit score don’t include how much money you make.
However, the way income can affect a credit application is through your debt-to-income ratio.
Lenders evaluate your ability to repay debt. Your income is measured against how much you may owe other lenders, which can impact your approval odds for credit products. Just because someone has a high income doesn’t mean they aren’t carrying a lot of debt, which can impact their ability to pay back a new loan or credit card. And, if someone has a lower income but a long history of repaying debts on time and as agreed, lenders may look more favorably upon that person.
Here we’ll discuss how lenders calculate your debt-to-income ratio and how that affects your credit score, as well as the five components that make up your credit score.
The 5 components that make up your credit score
The most common credit score used by lenders is a FICO score. It’s comprised of five key factors, listed below by how important each factor is:
- Payment history (35%): Whether you paid on time or not.
- Amounts owed (30%): This is the total amount of debt you’re carrying measured against the amount of credit that’s available to you across all accounts. This is also known as your credit utilization ratio.
- Length of credit history (15%): How long you’ve had credit.
- New credit (10%): How often you apply for and open new accounts.
- Credit mix (10%): The mix of your different credit accounts (ie. credit card, installment loans and finance company accounts).
To have a credit score, you need to be actively using credit. According to FICO, that’s defined as “at least one account that has been open for six months or longer and at least one account that has been reported to the credit bureaus within the last six months.”
How your debt-to-income ratio is factored
While income doesn’t directly factor into your credit score, your ability to repay does when applying for new credit. Lenders want to know if your income is sufficient to cover any credit lines they extend to you. They do this by calculating your debt-to-income ratio. This is all your monthly debt payments divided by your gross monthly income.
Let’s take an example where you have the following monthly payments:
- $1,500 for your mortgage
- $200 for credit card debt
- $150 for an auto loan
- $150 for all other debt
Add that up and your total monthly debt is $2,000. If your gross monthly income is $6,000, then your debt-to-income ratio is 33% ($2,000 / $6,000).
“If you have a high debt-to-income ratio, you’re just asking for trouble,” said Matt Schulz, CompareCards.com chief industry analyst. “It can make it hard for you to get another loan if you want one, but most important, it means that you’re more likely to have issues paying off the loans that you currently have.”
Increase odds of credit approval by decreasing your debt load
If you calculate your debt-to-income ratio and it’s over 43%, that is considered high, according to the Consumer Financial Protection Bureau. To lower your debt-to-income ratio, you should try to pay down any outstanding debt you owe before applying for new credit. While you may be unable to pay off your mortgage, you can evaluate other daily expenses to see where you can cut back in order to apply more funds to personal loans and credit card balances. A debt-to-income ratio at or below 36% is considered acceptable.
Another option to reduce debt is to increase your income through a side gig. Plus, know that if you have any other sources of income to report on credit applications, such as alimony or child support, you can include these to lower your debt-to-income ratio.