Creditworthiness and Its Effect on Your Buying Power

by Dawn Handschuh, Personal Finance Writer   

Tighter bank-lending standards have made all things related to credit take on heightened importance these days. You may have heard the term "creditworthiness" tossed around and wondered what exactly it means.

Simply put, creditworthiness refers to how well individuals manage their household finances and, more specifically, their credit and debt. Do they pay their bills on time? Have they ever experienced a bank foreclosure or personal bankruptcy? Do they carry a wad of credit cards in their wallet, or do they use credit more sparingly?

There are many variables that determine an individual's creditworthiness. Since lenders want to minimize the risk of default or delinquency, most banks check the creditworthiness of prospective borrowers by looking at their credit report and credit score.

Credit scores, which assign a numerical value to a borrower's credit history, are used as a key tool by banks to measure creditworthiness. FICO^® credit scores range from the low 300s to the mid-800s, with an average national credit score of about 692, according to Experian, a credit-reporting bureau. 

The higher your score, the more likely you'll be approved for a home loan, car loan, student loan or home equity line of credit, and the better your chances of qualifying for the most competitive rate. If your score is mediocre, you may still get your loan approved, but you may have to pay a higher interest rate.

Because thousands of dollars in additional interest payments could be riding on your creditworthiness, it's wise to check your creditworthiness at least a few months before you apply for a loan. By doing so, you'll give yourself valuable time to improve your credit score and your chances for loan approval.

Despite the emphasis by lenders on the all-important credit score, an interesting 2009 study by researchers at Rice University in Houston indicated that "creditworthiness" correlates with "trustworthiness" in some people's eyes. 

The study looked at 6,800 loan applications on Prosper.com, an online lending site. Researchers hired 25 people to rate the applicants' trustworthiness, and the probability they would repay a $100 loan, based only on the borrower's photo. Those judged as being trustworthy were in fact more likely to get a loan from Prosper.com lenders, and their credit scores were about 20 points higher than those deemed untrustworthy. "Untrustworthy borrowers were 7% more likely to default on their loan than a perceived trustworthy borrower with the same credit score," a Reuters report said. 

Despite the intriguing implications of this study, we can still be pretty sure that banks will continue to use credit scores as the primary measure of creditworthiness for the foreseeable future.