What Is Creditworthiness ? Full Definition & Why It’s Important (2024)

Getting a loan can be a challenge. There are many considerations that will come into play when a bank or other lending institution makes a decision on offering a loan or a credit card. The creditworthiness of a borrower is near the top of a bank’s decision-making process. It’s important for consumers to build a creditworthy history. There are different levels of creditworthiness. Those who are near the bottom of this hierarchy will wind up paying higher interest costs while those who are deemed the most creditworthy will pay much less in interest. The difference between interest payments on a big purchase like a mortgage could wind up in the thousands or tens of thousands over the life of a loan. That’s a major reason why creditworthiness is such a big deal.

Creditworthiness Definition

When looking at the concept of creditworthiness, it’s important to first define the term. Simply stated, a person’s creditworthiness is an estimate as to how likely that person is to repay his or her debts. Conversely, creditworthiness is also utilized to find out who will be likely to default on their payments. Banks are not in the business of losing money. When borrowers fail to repay their debts, banks are not able to take in the interest payments they estimated. Frequently, banks will use a person’s FICO credit score to assess his or her creditworthiness.

Furthermore, when banks make loans, they take on risk. The money they loaned could be invested in other areas. When borrowers fail to pay, not only does a bank stand to lose interest payments it was anticipating, it can also lose a sizable percentage of the capital it loaned to the borrower. The risk is even higher for unsecured loans. A borrower has to put up real property as collateral for a home mortgage. A car serves as collateral for a vehicle loan. The bank can repossess these types of property.

Credit cards are unsecured debts. There’s nothing backing them up. Therefore, even those who are quite creditworthy can find their credit cards come with some pretty hefty interest rates. However, those who have a lower level of creditworthiness will likely have even higher interest rates. Overall, a person who is deemed creditworthy will be more likely to access loans or credit cards when they need them, and they will also get better interest rates on their debts. This point will mean that those with better credit scores will likely come out well ahead financially when compared to those who have poor scores. Many thousands of dollars in interest costs are at play over a person’s lifetime.

Not only will those with higher levels of creditworthiness be able to access loans at better rates, but there are also other factors at play. For example, many prospective landlords or employers will perform a credit check. An employer may decide to look elsewhere when an applicant has a poor credit score. Therefore, it’s very important to cultivate a positive credit profile.

How to Check Your Creditworthiness

There are a couple of options people have for checking their creditworthiness. If you want to check your creditworthiness, the easiest option is probably checking your credit score. Many banks and credit card companies now offer this number as a benefit for those who hold accounts. By simply logging into your credit card account, you can click on the link for checking your FICO score and learn where you stand. Usually, this information will be drawn from one of the three major credit reporting agencies that are currently in operation.

The second option for checking your creditworthiness is ordering a credit report. Every US consumer is entitled to receive one free credit report each year from the major credit bureaus like Equifax, TransUnion, and Experian. Every year, it’s a good idea to check your credit report. While these reports are used to calculate your credit scores, they also have additional information that might be pertinent to your creditworthiness.

Your credit report will list all sources of credit that you’ve been extended. There will frequently be errors in these reports. Some accounts might be listed twice. Others might belong to someone with a similar name. Still, others could have been opened in your name by someone looking to engage in illegal activities. If you have any errors on your report, the credit bureaus have to remove them. However, you have to contact them in writing. If you don’t know what is currently showing up on your credit report, you will be unaware of any errors that might be on it. Therefore, you’ll want to check both your credit scores and your credit report because these are the main sources banks and other lenders will use when they go to extend credit to you.

How Do Creditors and Lenders Determine Creditworthiness?

When it comes to determining your creditworthiness, lenders will look at your credit score. Your credit score is a number that ranges from 300 to 850. The higher the number, the better you look to the banks in terms of your credit risk. A credit score over 700 is considered excellent, and some people are even able to get above 800. These folks will have access to the most lucrative credit card offers. They will also be able to access credit more easily and at lower interest rates. If you’re below the 600 level, you may still be able to access credit, but it will come with a higher borrowing cost. There are five basic components to figuring up your credit score.

• Payment history
• Amounts owed
• Length of credit history
• New credit
• Types of credit used

Payment History

This is the most important portion of your credit score, and it will go a long way toward determining your creditworthiness. Your payment history makes up 35% of your credit score. Things that you’ll want to worry about in this regard are missed payments. As long as you’ve made timely payments in the past, you should have a solid credit score. Any payments that are more than 30 days late will show up as a negative mark on your credit score, and they will make you see more risky for lenders. Banks like to get paid, and if you’ve been late in paying other people, banks fear you might be late in paying them.

Amounts Owed

This portion of your credit score is sometimes known as your credit utilization. The amounts you owe make up 30% of your credit score. The credit bureaus look into how much of your available credit you’ve used up. A lower number in this regard will have a better effect on your credit score than a higher number.

For example, whether you have a single credit card or multiple cards, you’ll have a total credit line. If you have a combined line of $10,000 and you’ve charged $2,500, you’d have a total credit utilization of 25%. This would be a good sign because the number is relatively low. On the other hand, if you’d charged $9,000 to these accounts, your credit utilization would rise to 90%. This would be a major red flag to the credit bureaus. Your score would suffer as a consequence.

Length of Credit History

Banks like to see that you’ve made your payments on time. Even more, they like to see that you’ve made your payments on time for a long period of time. If you’ve been making on-time payments for 20 years, you can expect your credit score to be higher than a person who has only been making on-time payments for two years. Because banks like to see lengthy payment histories, it can pay to keep your oldest credit card open as long as the annual fee is not too prohibitive. The length of your credit history makes up 15% of your total credit score.

New Credit

Opening up too many new credit cards can have a negative impact on your perceived creditworthiness. Each hard pull of your credit report will result in a slight drop in your credit score. If you open up too many new cards, the credit bureaus and banks can think you’re in dire financial straits. This portion of your credit score makes up only 10% of your total score.

Types of Credit Used

The final component of your credit score is also worth 10%. This portion of your credit score is tied to the different types of accounts you have open. If you can juggle making a couple of credit card payments, a mortgage, and a car payment, the credit bureaus will look at you more favorably than a person who only has a mortgage loan.

Factors Which Do Not Affect Creditworthiness

There are several factors that do not impact whether lenders can view you as creditworthy. Some of these are tied to anti-discrimination laws. For example, your gender, race or religion cannot legally factor into whether a bank gives you a loan or a credit card. Banks do not take your education level or lack thereof into account, nor do the credit bureaus use this information to calculate your credit scores. Additionally, banks are not allowed to take any public assistance you might receive into account when making decisions on your creditworthiness.

On the financial side of the ledger, there are some additional factors that will not affect your creditworthiness. The size of your bank accounts will not come into play, nor will the size of any retirement accounts you might have. While these might affect your capacity for paying off any debts, they do not necessarily make you more or less likely to default. That’s why banks are so concerned with looking at your payment history when extending credit.

How You Can Improve Your Creditworthiness

It might seem that you have little control over whether banks view you favorably. This is not the case. There are steps you can take to ensure that you build up your credit scores and your creditworthiness over time.

First, you’ll want to make your payments on time. You should pay every bill you owe on or before the due date. Once payment is 30 days late, it’s likely the creditor will report it to a credit bureau. As noted above, payment history is the largest component of your credit score. If you want a high score, you absolutely have to make your payments on time. Setting up automatic payments can help you ensure that your bills are paid on time each month.

It might seem counterintuitive, but if you’re looking to build a high credit score, you might want to open a new credit card. Unless you can get a large signup bonus for the card, you’ll want a no-fee card. A new credit card can help you in a couple of ways. First, it will increase the amount of credit you have available. This will lead to a second benefit. As long as you don’t go on a major spending spree, a new credit card should cut down on your credit utilization percentage. This makes up the second-largest percentage of your credit score, so it could definitely make sense to open another credit card.

Another step that might help you improve your credit score is checking your credit report. If there are any errors that negatively affect your credit score, you’ll want to dispute them immediately. Credit reporting agencies are required by law to remove any errors from your report. If they negatively impact your credit score, you could see a very rapid improvement just from contacting the credit bureaus. If there are negative marks that are accurate, you’ll just have to follow the strategies above. Those cannot be removed. You can work with a reputable credit repair service who will undertake this work on your behalf too.

Lenders are concerned with the creditworthiness of their clients. That’s why it’s important for you to cultivate a good credit score. A good credit score can allow you to save many thousands of dollars over your lifetime. Those who have poor credit scores tend to have trouble getting ahead in life because of the higher cost of borrowing they’ll experience. Additionally, it might be difficult to rent a house or apartment or to get some jobs if your credit is shot. Tracking your score over time will allow you to know when and if it’s a good idea to take out a mortgage or credit card.