What is Creditworthiness in Banking Industry?


Creditworthiness – Meaning & Definition

Creditworthiness is a measure of your eligibility to receive a loan as per the lender’s assessment. To determine your creditworthiness, lenders assess your repayment history and financial behaviour.

Creditworthiness is measured by your credit score, a three-digit number ranging from 300-900. A high credit score implies strong creditworthiness and increases the borrower’s chance of getting a loan.

KEY TAKEAWAYS

  • Creditworthiness determines the ability to qualify for a loan based on the lender’s evaluation.
  • Creditworthiness can be improved by paying bills on time and managing debt responsibly.
  • While measuring the creditworthiness of an individual borrower, lenders consider the 5Cs of credit such as capital, character, capacity, collateral and conditions.
  • Several options exist for improving your creditworthiness. You can increase your credit score through judicious debt management, increase your income, or offer a higher down payment.

Importance of Creditworthiness

  • Loan Amount and Terms: Creditworthiness plays an important role when you apply for a loan, as it determines your loan amount and loan terms. If you have a good credit score, there’s a high chance of getting the loan approved quickly and in favourable terms. On the other hand, if someone has a poor credit score (below 700), it may be harder to get a loan with the favourable terms.
  • Avoid Default Risk: Determination of credit reliability helps lenders minimise bad debt risk. Thus, financial risks or losses can be avoided.
  • Financial Planning: Proper understanding of credit risk helps individual borrowers plan their finances efficiently. It also forecasts accurate cash flow.
  • Competitive Advantage: Assessing the creditworthiness of individual borrowers, as a lender lets you offer credit to reliable customers, even when your competitors refuse them.
  • Stability in Cash Flow: Making sure most of the customers pay on time will thereby reduce the risks of cash flow.
  • Long-term Relationship: Carrying out business with trustworthy individuals and companies can ensure a long-term and sustainable relationship. This is important to achieve a steady growth in business.
  • Pricing Strategy: Understanding the risks of individual borrowers enables you to make the necessary adjustments in pricing strategies. You can offer suitable credit terms to those customers who are creditworthy. On the other hand, borrowers with low creditworthiness should be provided shorter credit terms.

Factors Affecting Creditworthiness

Various factors affect the creditworthiness of borrowers. Let’s understand the 5 C’s while evaluating a borrower for creditworthiness as described below:

  • Capacity

    The lender must determine if an applicant has a steady income to pay instalments without delay. They also need to learn about the source of cash with which a borrower will repay the loan amount. They must assess the credit history of borrowers using credit scores. Moreover, the lender will evaluate the current credit utilisation rate of the borrower along with their total debt.

  • Character

    A borrower’s character displays a financial record in the past. This helps lenders to determine whether borrowers make on-time loan payments. Credit information bureaus, including TransUnion CIBIL, Experian, CRIF High Mark and Equifax, compile credit history. The credit report includes the type of loan, details of past lenders, outstanding balances and more.

  • Capital

    Capital is an important factor when it comes to borrowing funds. Valuable assets such as land, jewellery, savings and any form of investment are considered here. These are generally categorised as safety buffers for lenders during any unforeseen circumstances.

  • Collateral

    There are two categories of collateral – fixed assets and financial assets. An example of a fixed asset is a piece of land. Stocks and bonds are categorised as financial assets. Some assets depreciate over time while others appreciate. Offering any collateral reduces the risk for borrowers compared to unsecured loans.

  • Conditions

    Certain conditions lead to investment risk. The two kinds of conditions that affect the creditworthiness - external conditions and internal conditions. External conditions include rates of interest, economic downturns or new laws that create a negative impact on the financial market. Internal conditions are the factors related to the borrower such as his/her employment history, usage, etc.

How to Improve Your Creditworthiness?

Here are a few tips to follow to improve your creditworthiness:

  • Pay Loans on Time

    Paying the monthly instalment timely helps lenders determine your creditworthiness. If you pay off more than your repayment capability, your interest charges are reduced, and your creditworthiness improves. Paying off the entire loan amount by the due date allows you to avoid interest charges on your credit card.

  • Pay Rent and Credit Card Bills on Time

    It is essential to pay your electricity, phone bills and rent on time. Missing due dates consistently will negatively impact your credit score. Moreover, missed payments categorise a lender as default which reflects on your credit report.

Final Words

Creditworthiness is your ability to receive a loan or repay the borrowed funds. Maintaining good creditworthiness gives access to new credit, favourable loan terms, and financial stability. Factors affecting creditworthiness include payment history, credit utilisation, types of credit, and recent credit applications. To improve creditworthiness, pay the bills on time, reduce debt, and limit new loan applications. Responsible financial habits make way for a better financial future and thus improve your creditworthiness!

Other Words

  • Collateral
  • Credit Report
  • Credit Rating Agency
  • Capital Assets

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