What is creditworthiness?
February 2, 2023 5 min read
When you want to borrow money, for a new car or with a credit card, your creditworthiness—or how you manage your financial obligations—comes into play. And lenders can use this information to decide whether or not to extend a line of credit to you.
Use this guide to learn more about what creditworthiness is, how it’s measured and some ways to improve it.
- Creditworthiness refers to how likely a potential borrower is to pay back a line of credit.
- Creditworthiness can be the baseline for lenders deciding to loan an applicant money for things like buying a car, taking out a mortgage or opening a credit card.
- Lenders may consider different factors when measuring an applicant’s creditworthiness, including the 5 C’s of credit—capacity, capital, character, collateral and conditions.
- Creditworthiness can be improved by taking steps to improve credit reports and credit scores.
Creditworthiness is a measurement of how an individual manages their financial obligations. It’s based on various factors like credit scores. Some of the things that can affect your credit scores include:
- Your payment history
- How much unpaid debt you have
- How many credit accounts you have—and what types they are
- How long your credit accounts have been open
- How much available credit you’re using
- Whether you have new credit applications
- Whether you’ve had a debt sent to collection, a foreclosure or a bankruptcy—and when that was
Why is creditworthiness important?
Creditworthiness matters because it can be the basis for lending decisions. It could also play a part in determining certain terms for the loan, like interest rates or fees.
Potential lenders that may consider a borrower’s creditworthiness can include mortgage or auto lenders, credit card issuers and even utility companies.
How is creditworthiness determined?
Lenders can gauge a potential borrower’s creditworthiness by accessing their credit reports, which paint a picture of an individual’s financial habits. Lenders may consider information from the reports, such as payment history, to decide whether or not to extend credit or approve a loan.
The 5 C’s of credit
Creditors might use a system—sometimes referred to as the 5 C’s of credit—to measure the creditworthiness of an individual. Here are the basics:
- Capacity: Capacity refers to the potential borrower’s ability to pay back a line of credit. Lenders may take into consideration the amount of debt a potential borrower has against their total income—also known as a debt-to-income ratio (DTI). Some lenders may have DTI requirements for approving a loan application, but the Consumer Financial Protection Bureau (CFPB) recommends keeping DTI at 36% or less.
- Capital: Capital is the portion of funds an applicant plans to put toward a loan. A down payment on an asset, like a car or a home, is an example of capital that a lender may consider when determining a borrower’s creditworthiness. Putting more capital toward a loan can make it easier for a borrower’s application to be accepted. It may also result in more favorable loan terms.
- Character: In relation to creditworthiness, character can be defined by a potential borrower’s credit history—or how financial obligations have been handled in the past. This can give lenders a better idea of a potential borrower’s credit risk.
- Collateral: Commonly defined as an asset that can be used to back a secured loan or secured credit card, collateral is considered part of an applicant’s creditworthiness. Lenders may have more confidence in extending a line of credit to a borrower using collateral—like a car or cash—to secure the loan. That’s because if you can’t make payments, the lender or credit card issuer can take your collateral.
- Conditions: As the name suggests, conditions refers to the actual conditions of the loan. For example, the interest rate and the amount borrowed can impact the overall lending decision. Conditions can also refer to the reason behind the loan. Lenders may be more likely to extend a line of credit for certain types of loans.
How to monitor creditworthiness
You can get a better idea of your creditworthiness by checking your credit reports and credit scores. Three major credit bureaus that compile credit reports are Experian®, Equifax® and TransUnion®. Credit scores are calculated based on information in your credit reports.
You have a few options for checking your credit scores and credit reports. They include:
- Obtaining a free credit report from each of the three major credit bureaus by visiting AnnualCreditReport.com.
- Considering a credit monitoring service like CreditWise from Capital One, where you can access your TransUnion credit report and VantageScore® 3.0 credit score anytime—without negatively impacting your score. And it’s free, whether you’re a Capital One cardholder or not.
- Seeing what options are available from credit bureaus or credit counselors.
By understanding what your credit score is, you can get a better idea of your eligibility when requesting a line of credit.
How to improve creditworthiness
By taking steps to improve your credit scores, you might become more creditworthy to lenders. Here are some tips:
- Maintain a low credit utilization ratio. The amount of available credit you use—or your credit utilization ratio—can have an impact on your overall credit score. Your credit score may improve if you take steps to keep this ratio below 30%, according to the CFPB.
- Keep hard credit inquiries to a minimum. A hard inquiry—or a request from a creditor to review your credit report when considering you for a loan or credit card—can affect credit scores. That’s why it’s a good idea to only apply for credit when necessary.
- Make on-time payments. Making an effort to keep payments timely can help improve creditworthiness. If you’re late on any payments, getting these up to date could also help your score over time.
- Consider applying for a secured credit card. If you’re building or rebuilding your credit, you may consider applying for a secured credit card. This type of credit card requires you to deposit money to the card issuer before you can use it. From there, you can make purchases—typically up to the security deposit amount. If card activity is reported to the credit bureaus, it could help you build or rebuild credit.
Creditworthiness in a nutshell
Creditworthiness can impact lending decisions when applying for a loan. This is why it’s important to understand your creditworthiness as a potential borrower—and take steps toward improving it, if necessary. You might also consider using CreditWise to monitor your credit score and get a better idea of your creditworthiness.