Lenders must evaluate the risks of lendingmoney to others. In commercial lending, creditors generally follow the same principles to evaluate a borrower's creditworthiness.
A creditor usually looks at three factors known as the "three Cs": capacity, capital, and character.
Capacity. The present and future ability to meet your financial obligations. Some of the areas examined would be your work history and the amount of debt that you already owe.Capital. Savings and other assets that could be used as collateral for loans. Even if you are not required to post collateral, many creditors express a preference that you have assets other than income that could be used to repay a loan.Character. This boils down to trustworthiness, promptness in paying your existing bills and other debts, and your credit history.
In days of old, the "three Cs" may have been all that were needed to get the nod on a loan, but in today's information age, much more is required, such as a credit report and credit score.
The credit report represents a long list of a person's payment history, credit accounts, and other information. The credit report itself is available free, but the credit score is not included. Perhaps more important is one's credit score—called a FICO score—which is named after the company that developed it: Fair Isaac and Company (www.myfico.com). The score is a three-digit number that falls between 300 and 850. The higher the number, the more confidence lenders have that a person will be able to repay their debt on time. Although other companies provide credit scores, the FICO is the dominant score used in the industry.
About 60% of people have scores of 700 or more. At 720, a person is considered a safe risk and typically receives a loan without a problem and at a low interest rate. The FICO score is weighted as follows:
35% payment history. Having a long history of making payments on time and no missed payments on all credit accounts is one of the top things that creditors look for.30% amount owed. This area measures the amount someone owes relative to all of the credit they have available to them. If a person is very close to the limit on all lines of credit, they can be deemed a potential risk in the ability to repay their debts on time.15% length of credit history. In general, a credit report containing a list of accounts opened for a long time will help a person's credit score. The score considers one's oldest account and the average age of all accounts.10% new credit. Opening several new credit accounts in a short period of time can result in a lowered credit score. Multiple credit report inquiries can represent a greater risk, but this does not include any requests made by the individual, an employer, or a lender who does so when sending the individual an unsolicited, "pre-approved" credit offer. In addition, to compensate for rate shopping, the score counts multiple inquiries in any 14-day period as just one inquiry.10% types of credit in use. A person's mix of credit cards, retail accounts, finance company loans, and mortgage loans is evaluated.