How Do Credit Card Companies Verify Your Income?
By Eva Norlyk Smith, Ph.D.
July 20, 2009
Many people wonder how credit card companies are able to verify that the amount they list as their annual income on a credit card application is correct. After all, when applying for a bank loan or a mortgage, some form of documentation of income is required, such as a copy of pay stubs and tax returns. Credit card companies, in contrast, don’t ask for documentation, when you apply for a credit card.
So how can credit card companies know that the number you put down is your actual annual income? The answer is, they can’t and they don’t. When evaluating a credit card application, credit card companies rely mainly on the applicant’s credit report. In the case of instant credit card applications, card issuers don’t even look at the credit report, but rely only on the applicant’s credit score, which summarizes the content of the credit report into a single, three-digit number. This is how instant approval credit cards can give you an answer in as little as thirty seconds.
In this respect, credit card applications are very different from mortgage applications and other types of bank loans. When applying for a bank loan, the bank relies in large part on your income as well as your credit score in evaluating the loan. This is because banks in part base their loan decision on a person’s Debt-to-Income ratio (DTI).
The Debt-to-Income ratio is a measure of how much debt a person can afford to carry. The ratio is calculated on the basis of the relation between a person’s monthly income and the sum total of his or her monthly financial obligations. If a large portion of a person’s monthly income is already committed to fixed expenses, like other loan payments or a high rent, that person is less likely to take on more debt. If the DTI ratio is low, on the other hand, there is greater likelihood that the person will be able to pay off the debt over time.
Unlike banks, credit card companies don’t try to predict how much debt a person can afford to carry based on their income. Card issuers instead rely on credit reports and credit scores, which predict how likely a person is to manage credit responsibly based on how much debt the person currently has, his or her previous experience with managing credit, and his or her past payment history.
This way of evaluating a person’s credit worthiness has both positive and negative implications. On the positive side, credit scores can be a great equalizer. Since credit scores are based on how responsibly a person has managed credit in the past, someone earning $25,000 a year can have as high a credit score as someone earning $125,000 a year. This is one reason credit cards have become so ubiquitous to American life—it’s not that hard to get approved for a credit card. You could be earning $10,000 a year, but as long as your credit score is half way decent, you can still get approved for a card with e.g. a $5,000 limit.
On the negative side, the easy access to credit that comes with credit cards also means that it’s easier for people to get in over their head in debt. With a bank loan, there are restrictions for how much debt a person can take on—banks, generally speaking, won’t approve people for more debt than they can afford. With credit cards, it’s fairly easy to get approved for several cards and end up with a total credit limit that is higher than the debt load a person can comfortably afford to carry. Fortunately, this is a drawback that is easy to guard against. Simply pay off the balance in full every month to avoid accumulating any credit card debt.