What Affect Does My Income Have On My Credit Score?
Having loans can seem like a demanding and intimidating venture. As such, is it a better financial decision to stay away from them altogether? Does having few to no loans and a solid income mean that your credit score is high? Not necessarily. A high credit score is associated with actually having lines of credit open and being able to responsibly manage them. What’s more, having a healthy income does not necessarily mean that you’ll be approved for any loan that you want. You still have to have a good credit score. Let’s dive into what you need to know about your income in order to build a good credit score.
How Your Income Affects Your Credit
In short, your income does not directly affect your credit score. Just because you have money does not mean that you have a high credit score. Yes, income does play a large part in being able to pay your loans off, which will in turn improve your credit, but simply having income does not do anything for your credit score. The primary relationship your income has on your credit score is through your debt-to-income ratio. This is a representation of how much you owe (not counting elective spending) compared to how much you earn every month.
Through your debt-to-income ratio, your income can affect your ability to be approved for a new loan. When you decide that it’s time to apply for a loan, the bank takes a look at your current debt and your current income. What they are looking for is a stable debt-to-income ratio, something that isn’t so high that taking on more debt would throw you off-balance. If they feel that you’re stretched too thin, they’re likely to deny your loan application. In this way, having solid income definitely plays a huge role in whether or not you can be approved for a loan. The important thing isn’t just how much you earn, but how much debt you have compared to your income.
As I mentioned, having high income alone does not make a good credit score, which means your income only makes up half of the requirements for opening a new line of credit. The other half of what you need will fall into place if you become aware of what makes up a good credit score.
What Makes a Good Credit Score
A good credit score has balance. It’s a common misconception to think that having a decent amount of money and no loans equals a high credit score, but that’s just not the case. In order to have a good credit score, you must have loans.
You also need to keep the balance on those loans as low as possible and make your payments on time. As such, it’s very important to not take more loans than you can handle. For example, with something like a credit card, the best way to optimize your spending in a way that benefits your credit score would be to only spend a small amount and pay it off rather quickly. Having a maxed out credit card doesn’t look good for your credit.
Banks and credit bureaus want to see that you know how to responsibly spend money. They want to know that you can handle the credit limit that is given to you without overdoing it. That is why a credit card is such a good example. Maxing out your credit card also racks on fees and interest, which will make it even harder to pay off in addition to the fact that your balance is very high. If you’re trying to get approved for a new line of credit and you have a maxed out credit card, your bank is going to be hesitant to give you more debt when you’re already having trouble paying off what you’ve got.
In the end, a good credit score motto to live by is “work on what you’ve got”. Before you try and open any new loans, work on lowering the ones that you have. Not only will that improve your credit, but it will also open up some room in your finances to be able to comfortably handle a new loan, should you decide that it’s time.
How to Use Your Income to Improve Your Credit
This brings us to the next point: taking a broad look at your finances. You’ll want to break down your income versus expenses and create a budget based on these figures. Having an intimate knowledge of exactly where your money is going will help you fine tune things and understand where cuts can be made, and maybe where you could stand to spend a little bit more.
Of course, your bills are the most important part of your budget, and that’s where you’ll be able to help improve your credit via your income. Consistently making loan payments on time will add positive details to your credit history, which will influence the calculation of your credit score. This means things like student loans, credit cards, car payments, and mortgages all affect your credit score and should be prioritized accordingly. The lower your monthly debt payments, the better your debt-to-income ratio, and the higher your credit score can be.
In addition, knowing how much room you have left in your budget can help you plan for the future. You can make plans for paying off a few debts, which can free you up for your next financial milestone, like buying a new car or home. Being in touch with your finances will help you shop around with confidence knowing what price range you’re comfortable with without hurting any of your other financial obligations.
Income absolutely plays a huge part in having good credit. Without a steady income you’d never be able to apply for a new loan with the confidence of actually being able to pay it back, which of course is what makes a good credit score. Although money does not equal a high credit score, as you can see, budgeting and planning for the future are essential to understanding your financial position as it relates to your credit and ability to apply for new loans.
Looking for other ways to improve your credit score? Find more articles and guides at the Fiscal Tiger credit score resource center.
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Trisha is a writer and blogger from Boise, ID. She is a dedicated vegan, an avid gamer, cat lover, and amateur SFX artist.
This post was updated December 14, 2017. It was originally published September 27, 2017.