You are probably already aware of how important your credit score is when it comes to getting a loan. It is also true that there are other factors that are important when it comes to being evaluated for your creditworthiness. Many lenders want to know your income so that they can determine whether or not you will be able to make your loan payments. This makes sense. However, you might be surprised to learn that lenders may not have to rely solely on your word and your tax return information.
Double Checking Your Earnings with Credit Bureau Income Estimations
Since the Credit CARD Act was passed, and the Federal Reserve came up with rules regarding lending, creditors must make greater efforts to verify your income. Just requiring documentation isn’t enough, though. The Wall Street Journal reports that the Federal Reserve is allowing lenders to use income estimates made by credit bureaus in their decisions to accept — or reject — your loan application.
Here is what The Wall Street Journal reports about how the credit bureaus estimate your income:
The bureaus use credit-record information, such as the size of your credit lines and the age and size of your mortgage, and plug it into models to predict your earnings. Those estimates also may be used to double-check the income you report on credit applications or to determine if you should be pre-approved for credit.
Unfortunately, when you pull your credit report, looking for errors, your income estimate isn’t visible to you. If a creditor rejects you based on the income estimate that the credit bureau has for you, you do get a second chance to prove that your income is higher than the credit bureau thinks it is. This is small comfort for entrepreneurs and others who may not have income sources that fit neatly into a categorized box.
Will Your Income Be Underestimated?
Another interesting consideration with this mode of predicting your income is that you might be dinged because your credit lines are not big enough, or because you chose to purchase a modest home instead of springing for a McMansion. I don’t know what the credit bureaus estimate my income at, but if they used some formula that used something similar to a 28/36 qualifying ratio, and went backward, my income would be estimated to be significantly lower than it is, since my mortgage payment less than 20% of my monthly income, and my total debt to income ratio is much less than 36%.
I’m sure (at least, I hope) that credit bureaus use a more complex formula to estimate my income. But the point here is made. This appears to be one more way that responsible financial habits can actually lead to penalties in the loan qualification/low interest rate game. The idea that your financial situation can be reduced down to a computer formula is a little disappointing, since it discourages lenders and other financial service providers from actually understanding your financial situation — especially if that situation isn’t easily classified.
Of course, the use of income estimations in just one more illustration of how financial privacy is becoming increasingly scarce. Technology makes it easy for lenders and others to compile data about your spending habits (even down to a specific purchase at a specific store), your employment history and even your liquid assets. All of that information could, in the future, be used to determine whether or not you qualify for a loan, or the best interest and insurance rates.
What do you think? Is Big Brother too prevalent in finances today?