What is Credit Worthiness?
The term creditworthiness defines your ability to repay a loan. Creditworthiness is based on your credit history, employment status, and current income. Lenders use this information to decide whether or not to give you a loan and at what interest rate.
At Clarity, we see creditworthiness as more than just a score to keep you worrying at night. Instead, we view it as your personal relationship with money. Check out our guide to learn more about improving that relationship for a better financial future.
How Is Creditworthiness Calculated?
There are a few different ways to calculate creditworthiness but combining your credit score and debt-to-income ratio (DTI) is the most common.
Credit scores are numerical representations of your creditworthiness based on the information in your credit report. There are a few different credit scores, but the most popular is the FICO score. FICO scores range from 300 to 850 - the higher your score, the better. For example, a score of 720 or above is considered excellent, while a score of 580 or below is considered poor.
Debt-to-income ratio is a percentage ratio of your monthly debt obligations to your monthly income before taxes. Luckily, calculating your DTI is pretty easy compared to your credit score.
- To start, add all your monthly debt payments (student loans, credit card payments, car loans, etc.) together. Then, divide that total by your pre-tax (gross) monthly income. This will be the total amount you make before taxes and other deductions are taken.
- For example, if your monthly debt payments are $1,500 and your monthly income before taxes is $5,000, your DTI would be 30%.
- DTI is important because it shows lenders how much of your income is going towards debt. A high DTI means you're using a large percentage of your income to pay off debts, which can create shaky creditworthiness. Lenders prefer to see a DTI of 43% or less.
Factors That Affect Creditworthiness
It doesn't matter how much money you have in the bank or how much debt you have; your creditworthiness can be affected by several factors.
Credit Utilization
This is the amount of credit you're using compared to the amount of credit you have available. It's typically represented as a percentage, calculated by taking your current credit card balances and dividing them by your credit limits.
For example, if you have two credit cards with credit limits of $5,000 and you currently have balances of $2,500, your credit utilization would be 50%.
Payment History
This is a record of whether or not you've made your payments on time. Late or missed payments can hurt your creditworthiness, while a history of timely payments can help improve it.
Credit Mix
This refers to the different types of credit you have, such as revolving credit (like credit cards) and installment loans (like mortgages). Having a mix of different types of credit can improve your creditworthiness.
Credit History
This is a record of your credit usage over time. A longer credit history can improve your creditworthiness, while a shorter credit history can hurt it.
It's important to remember that your creditworthiness is constantly changing, so you should regularly check your credit score and report to see where you stand. This will help you make the best decisions for your financial future.
How to Improve Your Creditworthiness?
Income earners at all levels should take steps to maintain and improve their creditworthiness. If your creditworthiness is good, you'll have an easier time qualifying for loans and credit cards with favorable terms.
More importantly, you'll be able to negotiate better terms for current or future debt incurred through financial hardships, life changes, or unexpected expenses.
There are a few different things you can do to improve your creditworthiness:
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Make all your payments on time. This includes credit card bills, mortgage payments, car loans, and any other type of loan you have. Payment history is one of the most important factors in your credit score, so it's important to stay on top of your payments.
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Keep your credit utilization low. This refers to the amount of debt you have compared to your credit limit. It's best to keep your credit utilization below 30%, but ideally, you should aim for 10% or less.
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Check your credit report regularly. Every year, you're entitled to a free credit report from each of the three major credit bureaus. Reviewing your credit report regularly can help you catch errors and identify potential fraud.
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Have a mix of different types of debt. This is also known as diversifying your debt portfolio. A mix of revolving debt (like credit cards) and installment debt (like mortgages) can help improve your credit score.
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Smart financial decisions (and a bit of luck) are the best way to guarantee that the measures above lead to a high credit score and good creditworthiness.
What Should I Do If I Have Bad Creditworthiness?
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If your credit score is low, don't panic. Most people maintain an average score at best, which isn't even all the time due to financial hardships that can be out of your control. The first step is to understand why your score is low, so you can take steps to improve it, including:
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Not having enough credit history. This is common for young adults just starting to build their credit. The best way to improve your credit score in this situation is to get a credit card and use it responsibly.
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Having too much debt. This is a common problem for people of all ages. If you're struggling with debt, the first step is to develop a budget and create a plan to pay off your debts. You can also consider using a debt consolidation loan to make your debt more manageable.
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Making late payments. This can damage your credit score, even if you're only a few days late. If you're having trouble making your payments on time, contact your creditors to see if they can work with you.
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Having negative items on your credit report. This can include things like bankruptcies, foreclosures, and collections. If you have negative items on your credit report, it's important to dispute them if you think they're inaccurate.
Once you understand why your credit score is low, you can start taking steps to improve it. Remember, it takes time to build good credit, so don't be discouraged if you don't see a major improvement overnight. Just make sure to keep up with your payments and keep your debt under control, and your credit score will gradually start to improve.
How To Build Credit While In Debt?
The cycle of debt can leave your creditworthiness in shambles. You're not alone if you've found yourself owing money with no end in sight and your credit score taking a hit as a result. But it's important to remember that you can improve your creditworthiness even while you're in debt.
There are a few things you can do to improve your creditworthiness when you've got tons of debt, and you are struggling to pay it all off:
Prioritize your debts. You should always make minimum payments on all your debts, but you may want to consider paying off your highest-interest debts first. This will save you money in the long run and help you get out of debt more quickly.
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Create a budget. This will help you see where your money is going and where you can cut back to free up some extra cash for your debt.
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Consider debt resolution. This is an option where professional negotiators work with your creditors to agree to accept less than the total amount you owe. This can be an excellent option for those looking to negotiate down several debts at once - and stop harassing calls in the process.
Ultimately, savvy, creative financial decisions are the best way to improve your creditworthiness, even when you're in debt. Keep working at it, and you'll find that your debt becomes more manageable, with an improved credit score being the end result.
Creditworthiness doesn't have to be a mystery. By following the tips above, you can improve your credit score and start on the path to a bright financial future.
Be sure to read our other Clarity blogs for more information about debt management, the benefits of debt relief solutions, and other helpful advice for improving your financial wellbeing.