It’s always exciting to get a raise, but this is especially true if you’re trying to improve your finances. More income means more available cash to save, invest or pay off debt.
You might be surprised to learn that a bigger paycheck doesn’t directly translate into a higher credit score. But the good news is that there are indirect measures you can take to boost your credit with your new income. Take a look at the details below for everything you need to know about this tricky topic.
Income isn’t factored into your score
First and foremost, it’s important to understand that income is not one of the data points FICO uses to calculate your credit score. The current algorithm only factors in behaviors that precisely relate to your behavior with borrowed money. These include:
- Payment history (35%)
- Credit utilization (30%)
- Length of credit history (15%)
- New credit inquiries (10%)
- Mix of credit accounts (10%)
So why isn’t income a consideration? The answer to this is twofold. For one thing, income is highly volatile and could theoretically change several times over the course of a short period of time. This makes it unreliable and difficult for the credit bureaus to track.
Also, remember the purpose of a credit score: It’s a tool that lenders use to assess the likelihood that you’ll repay borrowed money. Having a high income doesn’t necessarily mean that you’ll use that money to pay your bills.
But showing a strong history of paying on time and keeping your debt levels manageable is a good indicator that you’re a trustworthy borrower. This is why the FICO model uses the factors above – as opposed to other personal financial variables like income – to calculate your score.
Salary does affect your ability to get a loan
If you’re in the market for a loan and are having a hard time qualifying, you might be disheartened to learn that a raise isn’t the ticket to a higher credit score. But it’s important to remember that income is still a big factor that banks use when they’re deciding whether or not to give you a loan. This is because your monthly salary is part of what determines your debt-to-income ratio; aside from your credit score, this number might be the biggest factor a bank will use when assessing your creditworthiness.
Your debt-to-income ratio is calculated by adding up all of your monthly debt payments and dividing this figure by your gross monthly income. Most lenders want to see a debt-to-income ratio of 35% or less. Assuming you don’t take on additional debt the moment you get a raise, a bump in your salary will decrease your debt-to-income ratio.
This will make you a much more attractive candidate for a loan, even though your credit score will remain unchanged. And interestingly, adding another credit account to your repertoire might just be the ticket to a higher credit score after all (see below).
How to use a raise to boost your score
Even though your new, larger paycheck won’t directly impact your credit, there are some roundabout ways to parlay it into a higher score. For example:
Request a credit line increase – 30% of your credit score comes from your credit utilization ratio. Your credit limit is partially determined by your income, so a bigger salary could lead to a larger credit line. This will lower your credit utilization ratio, which could really help your score.
Just be sure to proceed carefully; this tactic only works if you resist the urge to spend.
Pay off debt – Another way to improve your credit utilization ratio is to pay down your debt. This is easier to accomplish if you have more income to work with every month, so using a raise to eliminate your credit card balance is a great idea.
Get a new loan – If you’ve been having a hard time getting a loan because of your debt-to-income ratio, a raise could help make you qualify. This could help your score by improving the diversity of accounts on your credit report.
But only open a new loan if you actually need it – don’t do it just for the sake of your score.
The bottom line: Getting a raise won’t put you on the fast track to better credit. But with the right moves, you can use your bigger paycheck to work toward a higher score. If you follow the Nerds’ advice, you’ll be on your way!
Getting a raise image via Shutterstock