Teacher: $45,000 salary
Lawyer: $200,000 salary
Who do you think has a higher credit score? The answer may surprise you.
I was recently told by an acquaintance he felt that credit scores are obviously “broken” as his FICO score was below 600—despite the fact that he makes over $150,000 a year. Seems like a reasonable conclusion, correct?
In theory, people who have a higher income should have more excess cash on hand to pay their credit obligations on time and their credit scores would reflect that dynamic. If you buy into that thinking, would it then also be true to assume that people who don’t make a lot of money are less likely to pay their bills on time and should therefore have lower credit scores?
[Related article: What’s a Good Credit Score in Today’s Economy?]
In reality, there is no guarantee that having a higher income will equate to having a high credit score and, thankfully, vice versa. Many people assume that your income is a factor considered by credit bureau scores and is very predictive of future credit risk. This is a credit score myth as credit bureau scores do not consider income since verified income is not available on credit reports. The credit score is focused on evaluating how you have managed your credit in the past (paying bills on time, have reasonable credit balances, only seek credit when needed) to predict you future credit risk.
So a teacher making $45,000 a year who pays her bills on time and uses her available credit responsibly could have a score in the 700s, as compared to a lawyer making $200,000 a year who has a score in the 600s because she occasionally misses payments, has a very large mortgage, high monthly car payment and several credit cards with high balances.
While income is not considered by the credit bureau score, it is an important piece of information a lender often requests and considers when you apply for credit. It provides insight into an applicant’s capacity to take on incremental debt. For example, while our teacher is a lower credit risk based on her score, she simply would not have the capacity (if her $45,000 salary is her only income) to take on a $3,000 a month mortgage obligation.
Considering your creditworthiness (via the credit score) and your capacity to safely take on additional debt (via verified income/debt ratios) helps lenders better determine whether they should extend you credit.
[Slide show: 11 Ways A Debt Collector May Be Breaking the Law]
Image: Ksayer1, via Flickr.com