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Understanding Ability to Pay: Income and How It Impacts a Credit Card

Updated on August 10, 2013
Retirees became an unintended casualty of the Ability to Pay provision
Retirees became an unintended casualty of the Ability to Pay provision

The Credit Card Act of 2009 was a game changer in many different ways. One major change that went into effect at the end of 2011 involved how credit card companies evaluate income as a part of the credit card application. Understanding how credit card companies now look at income is critical if you want to be approved for a credit card in today's market- particularly for young adults and two income households.


For years, credit applications asked applicants to provide their “Total Household Income”. The reasoning behind this was simple; banks wanted to know how much income their potential customer had relative to a number of different factors. However, the household income question left a significant grey area. Young adults still living at home with their parents could theoretically include that parental income. Stay-at-home spouses listed the income earned by the working party. Moreover, no matter what level of income was provided, issuers could still extend credit based solely on a customer's credit history. That's how a retiree living on social security could receive a $20k card that was more than their annual income and students with no income could receive a card at all.

Card issuers commonly set up booths such as this one to encourage customers to apply for their cards at sporting events
Card issuers commonly set up booths such as this one to encourage customers to apply for their cards at sporting events

What's your true housing payment?

How should you listing your monthly housing payment on an application? For homeowners, it's the whole mortgage payment
How should you listing your monthly housing payment on an application? For homeowners, it's the whole mortgage payment

The CARD act regulatory changes were designed to address the student issues. Banks could no longer provide the giveaways so popular with college students (the old “Apply for a card and get a t-shirt” routine). They also had to be able to prove, based on a potential customer's income and expenses, that the customer would be able to afford the card's minimum payment should the balances be maxed out (at the maximum credit line). Most importantly, that income had to come solely from the person applying for the card itself. No parental income, no spousal income; the customer themselves had to have their own income. The idea was to prevent a college student from being burdened down with credit card debt they were not yet prepared to support.


Calculating a customer's bills is a difficult proposition. Do you ask applicants to fill out a credit application that asks them to list every bill they have monthly? The focus for years has been on shrinking the credit application, not make it larger. Customers inherently do not like disclosing this kind of information and this is particularly true for customers with both good credit histories and large credit obligations. Instead, most issuers chose to use mathematical models and the customer's own credit report to determine a customer's total obligation.


Incredibly, the OCC in implementing this rule was blind to the potential consequences to non-working spouses and two-income families. In either case, the largest obligations (such as mortgages and auto loans) were usually held jointly. Yet as both parties were legally liable for the balance, the full payment counted against either party when applying for credit. The size of these payments make it extremely difficult for the lesser income to obtain credit no matter how good their payment history elsewhere may be.

Community property state?

Living in a community property state alters your legal rights when it comes to listing income
Living in a community property state alters your legal rights when it comes to listing income

Since it's inception there have been calls from banks and consumers to reform the so-called Ability to Pay (or ATP) rules. The threat of legal action has already made one major change. Spouses who live in community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) are legally entitled to include the income from both parties. The OCC itself offered a potential modification of how ATP is interpreted last fall but the change has not yet been approved or implemented. Banks want the rules changed because it prevents them from loaning to profitable customers. Customers want the rules changed because it prevents otherwise creditworthy applicants from receiving credit.


Until the rules themselves change, however, it's important to know both what the banks are looking for and how you can ensure your application gets the best possible consideration.

Co-sign a loan? List it

Don't forget to account for loans on your credit report that you co-signed for someone else
Don't forget to account for loans on your credit report that you co-signed for someone else

1. Know Your Obligations. Since the banks will calculate your obligations based on what's on the credit report, it's important to know exactly what open loans and lines of credit are currently on your report. Did you co-sign a loan for someone else? Do you have rental properties with active mortgages? Do you have business loans on your personal report or are any of your personal loans being paid for by a business? Divorced but still listed on an ex-spouse's home loan? Credit reports show all of these things and they also estimate a minimum monthly payment for the loans themselves (this is how banks calculate your monthly obligations).


2. Know Your Obligations, Part II. Another item that often causes ATP issues results from the credit report. Most loans accurately report their monthly payment but some do not. Home equity lines of credit, balloon loans, and American Express cards are particularly difficult to calculate based on the contractual terms of those products. So be sure to check the reported minimum payment for all of your active accounts and if no payment is listed, follow up with the bank's lending or credit department after applying.


3. Give Your Housing Payment. For most people, their largest monthly obligation is their monthly housing payment. Most credit applications will have the ability to capture this information but branch and telephone representatives, who receive bonuses based on how many applications they submit, may not initially ask for it. So don't be afraid to ask if the information is wanted because it will usually work in your favor; if you have a mortgage, the banks will ultimately see it anyway.

If you have a rental property, list the full amount your tenants pay- even if you're taking a loss monthly
If you have a rental property, list the full amount your tenants pay- even if you're taking a loss monthly

Don't be afraid to call

Most issuers have a credit department with live agents you can speak with about your application. Never be afraid to call them!
Most issuers have a credit department with live agents you can speak with about your application. Never be afraid to call them!

4. Be Accurate To Your Responsibility. As noted before, if you have a mortgage the banks will see it, so list the number accurately. If you're a renter, be sure only to list the portion of the monthly payment that you make. There's no reason to artificially increase that obligation. And if you have no personal housing payment (for example, living at home with parents), you may ultimately need to follow up with the bank directly. So many applications come through without a housing figure that some banks will estimate your housing payment if you don't provide one- resulting in ATP credit declines that should have been approved.


5. Rental Income. Many customers have rental mortgages on their credit reports yet forget to include that rental income on their credit applications. When applying, list the gross amount of money paid by the tenants instead of the net amount your profit from the property. The banks will be looking at the mortgage figure and you will need to show income to offset it. Similarly, if you have other credit obligations that you (or your spouse) are not paying for, you may want to consider including that towards the Gross Annual Income figure you list on the application.


6. Always Call In. If you apply for a card and receive a decline letter stating it was in relation to your obligations and income, call into the bank itself. Most credit card issuers have a credit department that will re-review your application and their number is often on the decline letter. The credit department's primary goal is to find ways to approve credit applications as more loans/lines equal more growth. In talking to a credit representative you will find out which obligations caused the decline and potentially be able to address them.


7. Remember, Gross Or Net. When filling out your credit application, read carefully whether the bank is asking for your gross income (before any taxes or deductions are taken out) or your net income (the actual amount on your paycheck). The bank's internal income and expense models will be based on which type of income they're asking for. If you provide net instead of gross you could potentially be declined for credit you otherwise are eligible for. When in doubt, list the gross figure.

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