What Does Creditworthiness Mean?
Credit worthiness attempts to measure your financial integrity and can determine how potential lenders perceive you. (Getty Images)
Creditworthiness, or how likely you are to repay a debt, is a major factor in whether you’ll be approved for a credit card, an auto loan or a mortgage. It accounts for your debt, your credit history and your ability to pay back loans.
Although each lender has its own way of measuring creditworthiness, you should know how to prove it.
You can signal that you’re creditworthy if you have the “three C’s of credit – capacity, character and collateral,” says Richard L. Ward, certified public accountant and member of the American Institute of CPAs’ Financial Literacy Commission.
Capacity refers to how much debt is in your name and if you can reasonably handle more. Character is about past behavior and if you’ve been responsible with making payments. And collateral is the means you have to back up any debt you’re taking on.
Your credit score can show that you are creditworthy as well. But it is only one part of the story. Jeff Richardson, spokesperson for VantageScore Solutions, developer of the credit-scoring model, says, “Your credit history is encapsulated in your credit score, but there are other factors a lender would consider, like income and employment status.”
No matter how you describe it, creditworthiness comes down to past behavior as the best predictor of future behavior.
What’s the Big Deal About Being Creditworthy?
It’s true that people with poor credit or limited credit history can find loans and credit cards, but those options are limited. “Creditworthiness ultimately gives you more options and flexibility,” Ward says.
It’s a must for some landlords, utilities and insurance carriers, which will check your credit report before doing business with you.
Having good credit puts you in a better position of control. The less creditworthy you are, the more likely you could be stuck with less-than-ideal terms and interest rates or resort to potentially predatory lenders, Richardson says.
“You never want to be in a position when you have to use a lender of last resort,” Richardson says. “You want to be in control. You want lenders to be selling to you – you don’t want to be selling yourself to lenders.”
From the lender’s point of view, evaluating your creditworthiness is all about hedging against risk.
Ward explains, “It’s important to them because it’s a risk they’re taking on in terms of lending. They want to make sure they’re going to get their money back. As a business, they’re not going to take on unnecessary risk.”
How Do Lenders Determine Whether You’re Creditworthy?
Processes and measures for determining creditworthiness will likely differ from lender to lender.
“Lenders all have their own models to determine whether a consumer is going to get a loan and at what interest rate,” Richardson says.
Lenders will present different offers to someone who has stellar credit compared with someone who has fair credit.
A score in the good or excellent credit range will generally qualify you for good terms and conditions. That said, lenders weigh other factors, such as your income, the size of your down payment, and assets.
What Can You Do to Improve Your Creditworthiness?
If you are planning to apply for a new line of credit soon, improving your creditworthiness is a smart move. For one thing, it will improve your chances of approval, but it can also mean access to better interest rates, which can save you money.
Becoming more creditworthy isn’t difficult, but it does take a bit of time and effort. Here are the key actions you can take to boost your credit score and, in turn, your overall credit health:
Clean up your credit. Your credit report and credit score will be the first things lenders consider when making credit decisions. You can quickly improve your credit score by focusing on the factors that matter most. That means paying down balances, paying off collection accounts, fixing errors and building a positive credit history.
Try to maintain a steady income. Lenders want to see that you’ve had regular work for the past couple of years, whether that’s a full-time job or another source of income that’s unlikely to change. In the gig economy, where many people freelance in lieu of traditional full-time employment, keep in mind that you may have to shop around for a lender that understands your situation.
“If you’re not a W-2 wage earner, it may be challenging to apply for a mortgage,” says Richardson, adding that banks may want to see two years of financial statements for reassurance that you have a steady income.
Shop around. If a lender doesn’t present an offer that you think matches your creditworthiness, explore other avenues, Ward says. A smaller institution, such as a credit union, may be more willing to take you on. The same idea applies anytime you have a relationship with a particular institution. That relationship can boost your creditworthiness.
Stay informed. Many free tools can help you understand credit and how different behaviors might affect your creditworthiness.
Head to CreditScoreQuiz.org, developed by VantageScore and the Consumer Federation of America, to test your knowledge and sort out fact from fiction.
Then, sign up for a free credit monitoring service like Capital One’s CreditWise, which also has a credit score simulator to show you how certain choices could affect your score. The service is free, whether or not you have a Capital One card.
Creditworthiness is neither a number or an empty buzzword. It’s something to strive for if you want to keep your finances in good health.
By improving your creditworthiness, lenders will have to compete for your business with the best products and terms that can save you money. And that’s a great position to be in.