The ABCs of Creditworthiness
Helping consumers understand creditworthiness basics.
Knowing more about creditworthiness and what affects creditworthiness will help to raise an awareness about one of the most important consumer tools we have today.
When looking at credit cards alone, a data report released by the Federal Reserve Bank of Atlanta in August 2019 found:
- 75.5% of Americans carry at least one credit card
- 46% of all Americans are likely to use a credit card on a purchase
- 55% of all Americans with credit cards have debt
- USA Today published in February 2020 that the average credit card balance was just under $6,200
No matter how you look at it, maintaining creditworthiness is absolutely necessary and it will continue to become more and more critical for every day living over the months and years to come.
Please take some time and read through the creditworthiness information; we’ve tried to highlight important facts that favor you as a consumer.
Creditworthiness by definition is the extent to which a person or an entity is considered suitable to receive credit, based on the creditor’s interpretation of how likely a borrower is to pay the loan back; the key phrase here is “creditor’s interpretation.”
We, at inVIVO credit, prefer to use emphasize creditworthiness rather than credit because creditworthiness is a result of credit; great, good, fair or bad, everything is about the strength of your creditworthiness.
There are variables in all equations used by creditors to calculate a borrower’s risk and each creditor’s equation will vary from the other’s, but much of the basis for lending will come from a borrower’s credit score:
- Payment history – 35%: Do you make your debt payments and if so, how do you make those payments and when do you make those payments? The most important thing for creditors is that you make your payments to ensure the creditors have their money paid back. Second to you making your payments, is whether or not the payments are made on time. Most lenders are not lending their own money which means they’re borrowing from another source, the same money that you’re borrowing from them. If you’re not making your payments on time, the lender is losing money in the form of interest which takes from the profits of their lending business. This is why lenders charge more interest to borrowers who show weaker creditworthiness; the higher interest paid by the borrower ensures the lender will not lose money because of potential late payments. Payment history accounts for a whopping 35% of your credit score. You want to make all your payments on time and if possible, even early.
- Credit utilization – 30%: Credit utilization is a ratio of the total amount of credit you’re using divided by the total amount of credit you have available. This ratio is viewed from two perspectives: First, by each credit account and second, by the sum of all your credit accounts. If you have a credit card with a $5,000 credit limit and you have a balance of $4,000 on it, your credit utilization for that card is may be considered high. If you have multiple credit cards with the combined total credit limit of $15,000 and your total combined balance on all the cards is $10,000, your total credit utilization may be considered high. VantageScore, developers of the VantageScore 4.0 recommended in this article that “consumers keep levels at or below 30%”. Your credit utilization ratios account for approximately 30% of your credit score so do your very best to keep your total revolving debt balances low as they relate to your revolving debt credit limits.
- Length of credit history – 15%: Credit history is a tougher component to control and as such, it weighs less heavily that your payment history and credit utilization but being 15% of your overall credit score, it still has some teeth to it and can take your credit score down when it should be an easy 15% add to your credit score. The longer credit accounts have been open, the more this will be a factor in strengthening your credit score, especially with credit accounts having lower utilization and that have strong payment history with no delinquencies. For younger individuals, credit history can often be what keeps their credit scores from moving into the higher 700 and 800 range because the credit age hasn’t had the time to mature. This is why we encourage our clients to consider keeping lines of credit open, even with little or no utilization. The longer credit accounts are open, the more those accounts will positively affect your credit history. If work is put into having a strong payment history and lower credit account utilization, a credit score will increase slowly but steadily over time as the credit accounts age.
- New credit inquiries – 10%: There are two types of credit inquiries when a lender or a creditor wants to review your credit; hard inquiries and soft inquiries. A hard inquiry takes place when a lender or creditor with which you’ve applied for credit must review your credit report as the basis for their decision-making process. This type of inquiry appears on your credit report as a new credit inquiry and as such, will influence your credit scores. Examples of the types of credit resulting in a hard inquiry are mortgages, auto loans, credit cards. Soft inquiries occur when you check your own credit or when a lender or credit card company checks your credit to preapprove you for an offer. Soft inquiries do not impact your credit scores. Having a hard inquiry on your credit report will not likely affect your credit score but having too many hard inquiries over a short period of time can affect your credit because it shows lenders you’re opening up numerous new accounts in a very short time and indicating that you may be overleveraging or in need of alternative means to pay bills. Having multiple inquiries for a specific kind of credit product such as an auto loan or a mortgage will impact your credit but not as much because lenders will presume to believe you’re shopping for the best rates. Inquiries only remain on your credit report for just over two years. New credit inquiries account for 10% of your credit score and are something that are well within your control so try not to cause hard inquiries unless the loan or credit card you’re applying for is absolutely necessary.
- Types of credit – 10%: There are three types of credit accounts you can open; revolving, installment and open. Revolving credit is the most common type of credit allowing you to borrow against as often as you like as long as you stay under the cap or credit limit. Examples of revolving credit are credit cards and home equity lines of credit. Revolving credit accounts typically require monthly payments of principle and interest if you don’t pay off the borrowed balance in full each month. Installment loans are loans that have been paid out to the borrower and require set monthly payments such as mortgages, auto loans, student loans and personal loans. Installment loans are also very common. Open credit accounts are less common; structured in a similar manner to credit card revolving credit but the balance borrowed must always be paid bacck in full each month. For the sake of your credit score, it would be ideal to have a variety of these account types but certainly not necessary. Credit types account for 10% of your credit score.
Now that you know where the emphasis is placed, the task then becomes improving the credit score.
There is a pretty large gray area between the worlds of great credit and bad credit so we define good creditworthiness as having the ability to get loans when you need them and even qualify for unsecured credit cards when you need to. Your loans and extended credit will cost you more in interest but you will be able to borrow.
Bad creditworthiness would be having credit that does not allow you to obtain loans or unsecured credit in many cases and in the few cases where a lender might extend credit to you, the interest rates will most likely overwhelm you in time and cause you to become late on your payments or even default on the loan in which case, your credit will only become worse.
Your credit report contains information about where you live, how you pay your bills, and whether you’ve been sued, or filed for bankruptcy. Credit reporting companies sell the information in your report to businesses that use it to evaluate your applications for credit, insurance, employment, or renting a home.
The federal Fair Credit Reporting Act (FCRA) promotes the accuracy and privacy of information in the files of the nation’s credit reporting companies.
Under the Fair Credit Reporting Act:
- You have the right to receive a copy of your credit report. The copy of your report must contain all the information in your file at the time of your request.
- Each of the nationwide credit reporting companies – Equifax, Experian, and TransUnion – is required to provide you with a free copy of your credit report, at your request, once every 12 months.
- Under federal law, you’re also entitled to a free report if a company takes adverse action against you, like denying your application for credit, insurance, or employment, and you ask for your report within 60 days of receiving notice of the action. The notice will give you the name, address, and phone number of the credit reporting company. You’re also entitled to one free report a year if you’re unemployed and plan to look for a job within 60 days; if you’re on welfare; or if your report is inaccurate because of fraud, including identity theft.
The Federal Trade Commission website had dedicated a Free Credit Reports page for consumers that houses some valuable information about pulling your credit reports as well as a link to AnnualCreditReport.com, a private, federally backed website geared towards assisting consumers such as ourselves. The button below will take you directly to the AnnualCreditReport.com free credit report page:
Unless you have a lot of cash on-hand, having strong creditworthiness can greatly enhance the quality of your life. There are always challenges that come up unexpectedly in life and when something happens that calls for more funds than one might have on hand, and having strong creditworthiness can save someone from becoming financially broken over night. If there’s ever an emergency, having strong creditworthiness can save a life.
The interest fee savings alone on a single loan or a revolving unsecured credit card balance can equate to thousands of dollars over a short period of time. And the stronger your creditworthiness is, the less expensive it will be when you want or need to borrow money or have credit extended which will make that credit easier to pay off and in much less time.
There are a number of things that can happen when managing debt that can adversely affect your creditworthiness such as:
- Making payments late
- Not making payments at all
- Skipping months of payments and then combining those months’ payments to catch up
- Pushing off collections so long that judgements are filed
- Applying for loans or credit requiring credit inquiries
- Closing out credit card accounts
- Utilizing large percentages of credit lines
In the way that not doing certain things relating to debt management can adversely affect your credit, doing those certain things can positively affect your credit:
- Making payments on-time
- Making payments as soon as statements are generated
- Keeping bills from going to collections
- Only applying for loans or credit requiring credit inquiries when needed
- Keeping lines of credit open
- Keeping credit line usage low relative to credit line limits
- Checking credit regularly
- Challending credit report items that are inaccurate or unsubstantiated
Main Scoring Model Breakdowns
FICO uses 5 key scoring factors; VantageScore uses 6 key scoring factors.
