What Lenders Look for When Deciding if You're Creditworthy
If you're in the market for any type of loan or would like to open a credit card account, it's important to know what factors lenders consider when deciding whether or not to give you credit. With that information in hand, you can work to put yourself in the best possible financial position before you apply.
Your credit history: The easiest way to define credit history is how long you've had credit and how well you've handled it. The longer you've had credit, the better.
Lenders look for a consistent history of paying your bills on time. They don't just look at credit card or loan payments. Lenders may also check to see that you've paid your phone, cable, cell phone, rent and utility bills on time. A pattern of late or missed payments makes you less creditworthy in most lenders' eyes. While some may still offer you a loan or credit card, your interest rate will be higher than a person with a better credit history.
- How much money you make: Lenders compare how much you earn each month with your living expenses and debts, such as rent or mortgage, utilities, food, other loan payments and so on. How much money you have left after paying these bills helps them decide if you have enough income to take on more debt. Many lenders look for a debt ratio (how much you earn compared to how much you owe) of less than 40%. For some types of loans, you will need to provide proof of your income, such as pay stubs or tax W-2 forms.
- How much credit you already have and how much you're using: Another key factor lenders consider is the amount of available credit you have and how much of that you're using. If you have several credit cards with high limits, even if you're not using all that credit, a lender may consider you less creditworthy because you could use that credit and then have difficulty making payments on a new loan or credit account. Lenders are also wary if your balance is close to your credit limit. Some experts suggest using no more than 30% of the credit available on each card.
- What types of credit you have: Lenders like to see a mix of different types of credit, including mortgages, car loans, credit cards, school loans, and personal loans.
- How many recent credit applications you've made: Some lenders see applying for several new credit cards at once as a sign that you may be in financial trouble. Many do not, however, worry about recent applications for mortgages, car, or student loans.
- Available collateral: In some cases, a lender will allow you to use property you own, such as a car or home, to secure a loan. It's important to remember, however, that if you use collateral to get a loan, if you do not make your required payments the lender can take your home or car as payment on the loan.
If you're not quite up to par in any of these areas, before applying for credit, take some time to get your finances in better shape. Pay down credit card balances, make all your payments on time, and cut your expenses if possible.
This article is for informational purposes only. For personalized financial advice, you should contact a qualified financial advisor.