You may have heard the term creditworthiness if you’ve ever applied for a loan or credit card. Creditworthiness is one of the most important financial terms and can an important role in whether you’re approved or denied for a loan or other financing.
If you’re thinking about applying for a loan or credit card soon, understanding how lenders determine creditworthiness can help you improve your odds of getting approved.
What Is Creditworthiness?
Creditworthiness is a borrower’s ability and likelihood to repay a financial obligation within the constructs of an arranged agreement. It can look different depending on the lender or type of loan you’re applying for.
Lenders and creditors rely on several factors, including credit score and payment history, to determine whether a borrower is considered creditworthy. Depending on the lender, the more creditworthy you are considered, the more likely you are to:
- get approved for a mortgage, personal loan, or credit card
- get approved for more money
- qualify for better terms and rates
Creditworthiness can look different depending on the lender or type of financial product. Mortgage lender standards may look different than those of a credit card issuer.
Factors that impact creditworthiness
Your credit score and credit reports are the primary sources used by lenders to determine creditworthiness. Credit reports contain several pages of information about your credit history, payment records, and other pertinent details.
Your credit score is a measuring tool that boils down information from your credit reports to a three-digit number that represents your creditworthiness.
FICO is the most popular scoring method among lenders, but other scoring methods are available, like VantageScore. Developed by and named after the Fair Isaac Corporation, FICO scores are calculated based on five components, each accounting for a percentage of the score.
FICO credit scores range from 300 to 850. Using credit scores allows lenders and creditors to boil down several pages of credit information to a single number. Your FICO credit score may vary depending on which credit bureau you check. Each uses slightly different methods to determine credit scores.
Shop loans and compare rates to find the best personal loan for your credit score.
Why Being Creditworthy Matters
Being considered creditworthy isn’t a badge of honor but does come with perks. It’s a distinction that is important for lenders and borrowers.
It’s important to lenders
Typically lenders and credit card issuers are most interested in your creditworthiness. It’s the primary factor in qualifying for a new mortgage, an auto loan or other loan products, or a new credit card.
Other businesses, like cell phone carriers and cable providers, are known to run credit checks to determine creditworthiness.
It could be the difference between getting approved or not
If you don’t meet a lender’s underwriting requirements, you may not be deemed creditworthy in their eyes. If that’s the case, you may not be approved for a loan or credit card or receive a less favorable interest rate.
It means you are less of a lending risk
Lending to someone who isn’t considered creditworthy is a risky investment for lenders and one they are often not willing to make.
Being considered creditworthy can also be less of a financial risk for you, especially if it means getting approved for lower rates.
From the Experts
Learn what a finance expert and an economics expert have to say about creditworthiness.
Meet the Experts
Kaufman Management Center
Leonard N. Stern School of Business at New York University
Professor Emeritus of Finance
Oregon State University
Associate Professor – Political Science
What is creditworthiness and why is it important?
Altman: In any capital market, especially ones involving small and medium size firms, and even individuals, it is critical to have a common language of credit. This transcends individual biases and efficiencies. This common language of credit is for firms to be categorized in terms of “bond rating equivalents”. This will give not only investors, but also the firms themselves, the knowledge and ability to negotiate a fair price of credit.
Johnson: Typically, creditworthiness is defined as whether someone can pay their existing debts on time—defined by the period of the loan—and in full. Creditworthiness is important because if banks are making loans to people that aren’t creditworthy, the risk of default increases, hence, causing banks to lose money.
What factors impact a consumer’s creditworthiness?
Johnson: A consumer’s income and job/income security are the big ones, which is why banks want to know these if you are going to take out a prime mortgage loan. But the loan terms (repayment conditions and the interest rate on loans) are also important determinants of loan repayment (if they are too steep, this will make repayment difficult). Credit histories, which can be gauged by credit scores, provide information to banks about a consumer’s record on debt repayments.
How do lenders determine creditworthiness?
Johnson: Typically with information about a consumer’s income and job, as well as their credit history via a credit report, which details the consumer’s “rating” in paying back their existing debts.
How You Can Improve Your Creditworthiness
Regardless of your credit, there are steps you can take to improve your standing. Follow these tips to improve your creditworthiness.
Review your credit reports and score
Knowing where you stand can help as you work to improve your credit. You can do that by reviewing and monitoring your credit.
Credit reports are available from all three major credit bureaus: TransUnion, Experian, and Equifax.
You can also receive a free copy of all three reports once a year at AnnualCreditReport.com.
Check your credit reports for errors or omissions that could unknowingly be negatively affecting your credit.
You can dispute them directly through the credit bureaus if you find errors. Keep detailed records and notes to refer to throughout the process.
Many credit cards come with free access to credit scores and credit monitoring. If you have a card with free access, use it to check your score frequently. Several websites offer free access to credit scores that are also helpful.
Pay your bills on time
Paying your credit cards and other revolving credit bills on time each month is one of the best ways to show creditors you are a responsible borrower.
If you struggle to pay bills on time, consider setting up automatic minimum payments if that’s an option.
Paying minimum payments may not help you avoid interest charges if you carry a balance month to month, but it will help you avoid late fees, which creditors report to credit bureaus.
Keep credit accounts open
The length of your credit history, or credit age, is another major factor in determining credit scores.
You may be tempted to close accounts once you’ve paid off your balance, but consider the ramifications before doing anything. Closing a credit account, especially one you’ve carried for years or decades, could drop your credit age considerably. If you don’t want to use the card anymore, stick it in a drawer somewhere for safekeeping instead of canceling it.
You should only consider closing a credit account if it carries an annual fee you don’t want to pay anymore.
Lower your credit usage
Credit utilization can also raise or lower your credit score affecting your creditworthiness.
Your credit utilization ratio is the total amount of available credit used, expressed as a percentage.
If you had credit limits totaling $100,000 and $10,000 in existing credit balances, your credit utilization ratio would be 10%.
Experts often suggest keeping your credit utilization under 30%, but there’s no hard and fast rule that a specific percentage will cause your credit score to drop. The best way to lower your credit utilization is to pay off debt without adding more elsewhere.
Using credit only when necessary is another way to keep utilization down.
Limit new credit applications
Having several credit inquiries in a short period can also negatively affect your creditworthiness. This is especially true of credit cards, which signal a hard credit inquiry with each application.
Some financial products, like loans, may operate differently. Often, these inquiries count as one if performed within a short period, typically 45 days or less.
Keep in mind we’re talking about hard credit inquiries.
Often, lenders allow you to check rates or prequalify for loans and other financial products. This is done through a soft credit inquiry, which does not affect your credit score.
When you apply for a loan, credit card, or other financial product, the creditor will perform a hard credit inquiry, which can cause your credit score to drop several points temporarily.
The impact of credit inquiries may depend on the number of accounts you have and the length of your credit history. Several credit inquiries for an individual with a short credit history may be viewed differently by lenders than those with a long, established credit history.
Consolidate your debt
If paying off debt or keeping track of bill payments is an issue for you, consider consolidating your debt.
A debt consolidation loan can simplify debt payoff, with only one bill payment to worry about. You could qualify for a lower interest rate than you’re currently paying on the consolidated accounts, depending on your credit.
Apply for a secured credit card
If you’re having trouble getting approved for a credit card, consider applying for a secured credit card instead.
Secured credit cards are great credit-building tools. Instead of securing a card based on creditworthiness, a secured credit card is secured with a refundable deposit.
Secured credit cards typically have low credit limits but can help you establish a credit history and a positive payment history through on-time, in-full payments.
