What is Creditworthiness? How Lenders Determine Your Risk Level

When people ask me what part of personal finance they should care about, I always tell them: your creditworthiness.

Being creditworthy is like having the golden ticket — banks and lenders will open their doors for you. You will likely secure lower interest rates on car loans and mortgages, and you may even end up with lower car insurance rates. 

In short, if you want to save money, then you need a good credit score.

In my personal experience, having good credit has opened so many doors and given me priceless experiences. Having good credit means I can qualify for travel credit cards that let me earn points I can redeem for free flights (like a two-week trip to Japan last year). 

It also means I can qualify for loans on my own and be eligible for low interest rates. This allows me to save thousands or even tens of thousands of dollars compared to someone with worse credit. 

Read below to learn more about creditworthiness, how to assess yours, and how to improve it.

Here’s what you should know about creditworthiness if you’re a complete novice:

Credit Reports

You’ve probably heard that your credit report is like a financial report card. When you look at your credit report, you will see all your current credit products, like loans, lines of credit, and credit cards. You will see each monthly payment, as well as whether you paid on time or more than 30 days late.

There are three bureaus that compile information to create your credit report: Equifax, Experian, and TransUnion. 

Lenders submit information to the credit bureaus. Most lenders will send information to all three credit bureaus, whereas some will only submit information to one or two credit bureaus. This is usually only the case with subprime loans.

You can find all three official credit reports at www.AnnualCreditReport.com. From there, you can look at your credit reports for free once a week with each credit bureau. 

To view your credit report, you will have to input personal information that proves your identity. This includes your birth date, Social Security Number, and full legal name. After this, you should be able to see your full credit report.

Credit Scores

Credit scores were created to help level the playing field and make it easier for people to be approved for credit. 

Before credit scores were required for loan applications, banks and credit unions would rely on subjective details, like character references, when deciding whether to approve someone for a loan or not. This also made it easier for companies to discriminate against borrowers from certain demographics.

But now, lenders must use credit scores, which are a much more objective (albeit not perfect) way to determine if someone is a good candidate for a loan, line of credit, or credit card.

If a credit report is like a financial report card, then your credit score is like your GPA. It’s a simple three-digit number that instantly gives lenders a basic idea of what you’re like as a borrower. 

Two main companies create credit scores based on information from your credit report: FICO and VantageScore.

“If a credit report is like a financial report card, then your credit score is like your GPA. It’s a simple three-digit number that instantly gives lenders a basic idea of what you’re like as a borrower.”

You’ve probably heard more about FICO, likely because about 90% of lenders rely on it when deciding whether or not to approve someone for a credit product. You’ll often hear your credit score referred to as your FICO score. 

VantageScore is another company that creates credit scores. However, it’s much less commonly used in real-life applications. Instead, VantageScore is more likely to supply the free credit score that you might see online.  

Another little-known fact is that consumers often have dozens of different credit scores. There are various algorithms used for different types of credit products. For example, the auto loan credit score algorithm may be different from the credit score algorithm for a mortgage. There may be a different score range for each type of loan.

In general, credit scores from both FICO and VantageScore can range from 300 to 850. However, it also depends on the exact type of credit score. Some specific types of credit score models range from 250 to 900.

Hare are the typical credit categories for both FICO and VantageScore:

Also, while the major components of a credit score are the same for both FICO and VantageScore, their scoring algorithms are different. If you check your FICO and VantageScore credit scores at the same time, you may notice a slight discrepancy. 

However, the difference should not be crazy. The two scores should still be in the same general range because the information coming to FICO or VantageScore is mostly the same: things are just weighed differently.

There are several factors that can affect your credit score. Here are the biggest ones:

Debt-to-Income Ratio

While your debt-to-income ratio doesn’t necessarily impact your credit score, it can impact your ability to get a loan. Your debt-to-income ratio shows how your monthly debt payments compare to your monthly income.

If the ratio is too high, you may be denied a loan. The exact limit depends on the type of loan. If you’re applying for a mortgage, you can have a maximum debt-to-income ratio of 50%, including future mortgage payments.

Payment History

Payment history is the single most important component in a credit score and is worth 35% of your total credit score. Payment history means you pay your bills, mostly your credit-related bills, on time. If you do, your score should improve or remain high. If you don’t, your score will suffer — a lot.

Many consumers underestimate how important it is to pay your bills on time. Having a positive payment history shows that you’re a responsible borrower.

However, you don’t have to panic just because you have made a late payment. Lenders will only report payments that are more than 30 days late to the credit bureaus. If you’re only a week or a few days late, that won’t show up on your credit report. 

On the other hand, the later you are, the more it can hurt your credit score. For example, a 60-day late payment is much worse than a 30-day late payment, and a 90-day late payment can be really devastating for your credit score. 

Here is a timeline of the repercussions as you fail to make payments:

Payment history mostly refers to credit products, not bills like utilities, subscription services, rent payments, and more. For example, if you pay your Netflix bill 30 days late, it won’t show up on your credit report.

However, if you are so late that a bill is sent to collections, then that will appear on your credit report. For example, let’s say that you have a medical bill that you ignore. If you don’t pay it after a certain length of time, the provider may sell your debt to a collection agency. 

Even an eviction can decrease your credit score if your landlord files eviction proceedings against you and sends the unpaid rent to a collection agency. A collection notice on your credit report can result in a 100-point score drop.

Plus, even if a late payment doesn’t hurt your credit score directly, you can still be assessed a late fee. The cost of a late fee will depend on the provider, but can range from $25 to $50. 

Credit Utilization Ratio

The second most important factor in your credit score is your credit utilization ratio, or percentage. The credit utilization ratio shows your total outstanding credit balance compared to your credit limit and is mostly calculated based on your credit cards, not term loans.

If your goal is to have the highest credit score possible, then your credit utilization ratio should be 10% or less. However, if you’re rebuilding your credit, then a credit utilization ratio of 30% or less is also a decent standard to meet.

Here’s how to calculate your credit utilization ratio. First, pick a current credit card and look up the current balance. Then, divide that figure by the total credit limit (not the remaining credit limit).

For example, let’s say you have a $1,000 balance on a card with a $4,000 credit limit. This means you have a 25% credit utilization ratio. However, if you had a $2,000 balance, then you would have a 50% credit utilization ratio, which would be higher than desired.

Here is another example based on someone who owns three credit cards with a total credit limit of $10,000:

There are two ways to improve your credit utilization ratio: pay down your debt or increase your credit limit. Paying down your debt is harder, but it can also help you pay less interest.

You can increase your credit limit by calling your card issuer and asking for a higher credit limit. Some credit card issuers will even let you file a request online.  

For example, let’s say you have a $2,000 balance on a card with a $5,000 credit limit. This means you have a 40% credit utilization percentage. If you get the limit increased to $6,000, then your credit utilization percentage will be 33%.

Having good credit doesn’t simply mean you can take out a loan. There are other doors a good credit score can open.

Access to Credit Products

The biggest reason anyone should care about their credit score is because they want to apply for a loan, line of credit, or credit card.

Very few products are available for those with poor credit, and if they are, they will have higher interest rates and fees. In short, you will spend so much more money as a consumer if you have bad credit.

The minimum credit score needed to apply for a loan or credit card is about 600, but this depends on the type of loan and other factors.

Interest Rates and Loan Terms

When you apply for a loan or credit card, an interest rate will usually be attached to the product. There is a direct correlation between your credit score and the interest rate you receive. The higher your credit score, the lower your interest rate.

For example, as of July 2024, here’s how the following credit scores correlate with the interest rate on a mortgage:

While this may seem like a negligible difference, it can have huge repercussions, especially over the life of a 30-year loan. If you pay 1% higher interest on a $300,000 loan with a 30-year term, you will owe almost $75,000 in extra interest. That’s enough to buy a couple of new cars, go on several vacations abroad, or pay for your child’s college education.  

Renting and Employment Opportunities

When you fill out an apartment application, you will likely have to consent to a credit and background check. Landlords use your credit report and score the same way that lenders do — to see if you’re a responsible party. 

There’s no particular minimum credit score that you need to qualify for a lease on your own. It just depends on the landlord and their policies. In general, a score in the mid-600s or higher will make it less likely that you’ll need to add a cosigner to the lease.

Your credit report may end up in the hands of a potential landlord or employer, meaning your creditworthiness could play a part in getting a job or qualifying to rent a home or apartment.

Also, some employers will also conduct a credit check during the hiring process.  This is more common if you work in a field that handles money directly or a profession where bribery is a concern. It also depends on your level of expertise. If you’re an entry-level employee, it’s less likely that someone will check your credit. 

However, if you’re a C-suite executive, the company may run a credit check. Finance, security, military, or other public service positions are more likely to run a credit check. But it is still fairly rare for most employers.

Whether you’re trying to fix a poor credit score or building one from scratch, the principles are the same. Here are some simple strategies to boost your creditworthiness:

Pay All of Your Bills on Time

Now that you know how important payment history is, you can work on making all your payments on time.

As far as payment history goes, you don’t have to pay your bills in full — just on time. Even a minimum payment counts toward a positive payment history.

One of the easiest ways to make sure your bills are paid on time is to set up autopay. Autopay is when the amount due is automatically withdrawn from your account on or before the due date. Autopay can help you avoid late payments and costly late fees. Also, some lenders may provide a slight interest rate discount if you sign up for autopay.

However, autopay isn’t perfect. Sometimes there are issues getting autopay set up, and if you think automatic payments are coming out of your bank account, you may not double-check until the payment is already late. 

It usually takes at least one billing cycle for autopay to go through after you’ve set it up. Make sure to double-check that your autopay has gone through.

Also, if you don’t have enough money in your bank account, then autopay may not work. If that happens, then the company may cancel autopay. You may have to manually set it up again.

You are not required to use autopay if you don’t want to. Some people, especially consumers who want to pay extra on their loans or credit cards, pay more than the minimum every month. However, if you’re not sure exactly how much extra you can afford to pay each month, you may prefer to make a manual payment.

If you’re more comfortable with manual payments, set recurring reminders in your calendar or phone so you don’t miss a payment.

Reduce Outstanding Debt

Your credit utilization percentage is another major factor in your credit score, so work on keeping your debt down, especially on your credit cards. One way to do this is to always pay your statement balance if you can. If you can’t afford to do that, pay as much as possible.

Also, if you have existing credit card debt, you can transfer the debt onto a new card with a 0% APR offer on balance transfers. This can help you pay down the balance without incurring unnecessary interest fees. 

A balance transfer card may be a good option to help reduce your debt if you have large balances on high-interest credit cards.

Most 0% APR balance transfer offers last between six and 21 months. If you pay off the balance before the offer expires, you’ll save a lot of money on interest — and boost your credit score in the process.

Credit utilization only applies to credit cards, not installment loans. And since credit cards typically have higher interest rates than installment loans, it’s better to pay down your credit card debt first before tackling other loans.

Regularly Check Your Credit Report

It might sound crazy, but you can do everything right and still have a poor credit score. One reason? Fraud. 

Data from the Federal Trade Commission found that one in five people has a mistake on their credit report, which could be negatively affecting their credit score.

There’s no such thing as checking your credit report too often, but you can check it too infrequently. It’s best to view it at least once a quarter, and some people like to check it once a month.

There’s no such thing as checking your credit report too often, especially when you have plenty of options to do it for free.

You can set a reminder in your calendar or on your phone so you don’t forget. You can also pick a specific day to check it, like the first or last day of the month. 

Nowadays, monitoring your credit score is easy because there are so many free services you can sign up for. These services can send you emails to let you know when something has changed on your credit report or with your credit score. As long as you read these emails carefully, you should not have any major surprises. 

Your overall creditworthiness shows lenders, banks, and credit unions if you’re responsible enough to lend money to. If you are, then you may even qualify for a more attractive interest rate.

However, if you’re not creditworthy, you may be denied — or only approved with a high interest rate.