Can You Have Bad Credit Even With a Good Income?
If you earn a modest income, it’s easy to be envious of the super-wealthy. They travel around the world, eat at Michelin-rated restaurants, and shop for high-end luxury items. They enjoy a lifestyle that’s nothing more than a pipe dream for most of us.
However, when it comes to credit, your score may be just as high, or higher, than billionaires like Bill Gates and Richard Branson. That’s probably not much consolation, but it is the truth.
It may seem like credit scores should increase with your income, but the truth is much more complicated. Read on for a deep dive into what makes up your credit score and why just being wealthy can’t protect you from bad credit.
Why credit bureaus don’t care about your income.
Despite what many people think, your credit score is completely independent of your income. People with $20,000 salaries can have good credit scores, just like those with $200,000 incomes can have poor credit scores.
Credit scores only look at one thing—your credit history. It doesn’t matter how large your 401k is or how much equity you have in your house. A credit score doesn’t show how much you earn, how stable your job is, or how much you save. Though a credit score is a popular financial barometer, it’s not a comprehensive measure of your financial situation. Credit bureaus don’t collect information about your income, only about how you treat the debts you’ve assumed.
“The purpose of credit scores is to help assess the risk a person will not pay a debt as agreed—regardless of income,” said Rod Griffin, Senior Director of Public Education and Advocacy for Experian.
A lender looks at your credit score because it reflects how well you manage your credit obligations. A high credit score means you’re dependable and reliable, and a poor credit score usually indicates negligent or irresponsible financial behavior.
Some consumers mistakenly think income is part of their credit score because lenders ask for it on applications and might use it as a reason to deny a line of credit. If you have a good credit score and low income, you might not qualify for a loan because the lender thinks the payments will be too high.
Conversely, if you have bad credit with good income, you can also be denied. According to Griffin, your credit history is typically more important to a potential lender than your income, because the former shows your track record of managing debt.
“Understanding the components of your credit report is essential because a strong credit history increases your access to the financial services you need,” he said.
How high-earners end up with bad credit.
Since income is not one of the five factors that determine a credit score, the wealthy are just as likely to have a low credit score as the people with lower income. The rich can miss payments, rely too heavily on credit, and open too many new accounts, all of which may lower their credit score.
On a practical level, it boils down to whether or not your income can support your lifestyle. We’ve all seen examples of lifestyle creep, where you start to scale up your expenses as your income increases, and the wealthy are no more immune to this. A busy mother of three working in a call center can attain a perfect credit score by diligently paying her bills, just like a superstar basketball player can tank his score with a few purchases he can’t afford.
However, wealthy people may also have a bad credit score or no credit because they don’t borrow money. If you can afford to buy your house or car in cash and only use a debit card, you won’t build up a credit history.
The fact is, a poor credit history doesn’t really matter if you don’t need to borrow money. Many financially independent or early retirees have no credit or poor credit because they only use their debit cards.
What makes up your credit score.
Though the exact algorithm is a secret, FICO uses the following factors to decide your credit score:
- Payment history: Your history of paying credit bills on time makes up 35% of your credit score. This is the most important component and also the easiest to improve. If you pay your bills on time every month, your credit score may increase. While missing payments repeatedly, your credit score will get affected. Switching to auto-pay will guarantee you’re never late again.
- Amounts owed: How much you owe relative to how much credit you have available to you constitutes 30% of your credit score. This is also known as your credit utilization ratio. If you owe $35,000 on your credit cards and have a credit limit of $100,000, you have a credit utilization ratio of 35%. Credit bureaus don’t like to see a ratio of more than 30%. Anything higher makes them worry that you can’t afford to pay down your balance and that you’re relying too heavily on credit.
- Length of credit history: How long you’ve had credit only counts for 15% of your credit score. The longer you’ve had your accounts, the better. The only way to improve this section is to avoid opening new accounts and keep your oldest accounts active.
- Type of credit: Lenders like to see a variety of credit accounts on your report, including student loans, auto loans, credit cards, personal loans, and mortgages. You won’t be heavily dinged for not having more than one or two different types of accounts, as this part only makes up 10% of your credit score.
- New credit inquiries: Any time you open or apply for a new line of credit, it shows up on your credit report. New inquiries account for 10% of your credit report. The more inquiries you have on your report, the lower your score will be. It takes one year for inquiries to disappear from your report, and if you’re applying for a big loan like a mortgage, it’s best not to have any recent inquiries on your credit report.
If you have a solid income and a poor credit score, there are plenty of ways you can increase your score quickly. Go through your credit report and look at any red marks. Are you bad at paying your bills on time? Or is your credit utilization ratio too high?
Address each reason you see a negative score and work on improving those areas. You may see a higher credit score in just a few months if you follow the right steps.
Rod Griffin is Senior Director of Public Education and Advocacy for Experian (Experian_US). He leads Experian’s national consumer education programs and supports the company’s community involvement and corporate responsibility efforts. Rod oversees the company’s financial literacy grant program, which awarded more than $850,000 in 2015 to non-profit programs that help people achieve financial success. He works with consumer advocates, financial educators and others to help consumers increase their ability to understand and manage personal finances and protect themselves from fraud and identity theft.
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