Credit Score vs. Ability to Repay a Loan

A credit score is a number that lenders use to evaluate the risk of lending you money. It is based on your financial history and it forecasts your ability to repay debt in the future. If you have a good credit score, you're considered less risky of a borrower than someone with a bad credit score.

How Do Credit Scores Work?

Your credit score is a number that impacts your ability to qualify for loans and credit. This score considers your financial history to determine your ability to repay debt. Lenders use your credit score to assess how risky it may be to lend you money.

Does Your Credit Score Determine Your Loan Repayment Ability?

Having a good credit score shows that you have a history of being a responsible borrower and that you can properly budget to repay your debts on time. With a good credit score, lenders are more likely to approve you for a loan and offer you more favorable interest rates and terms.

However, your credit score is not the only factor lenders use to determine if you can earn approval for a loan or line of credit. The amount of the loan or line of credit you are requesting can require measures beyond your credit score to assess if you can repay the loan. Here's how lenders use other factors to figure out if a loan is right for you.

 

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Factors that can determine loan approval

 

How Lenders Determine Your Ability to Repay a Loan

While most lenders will look at your credit score when deciding whether or not to approve you for a loan, they'll also consider other factors including:

Credit History

As reflected through your credit report, your credit history shows lenders how you have made or not made on-time payments towards your credit accounts — through credit cards, loans, or other regular bills. A positive credit history shows lenders that you have paid back your debts on time and increases their chances of approving you for new credit. Most credit histories will look back at your past seven years of credit use.

Conditions

Many lenders will want to know what the loan will be used for, to understand the purpose of the loan — especially as the conditions for an auto loan will be very different than the conditions of a home loan. If you have a long and stable employment history, a long-term loan of ten years or more will seem reasonable to a lender, but if you have a history of changing employers, a lender may find it risky to offer you a loan that must be repaid over a longer time period.

Capacity

Your capacity is your ability to repay a loan based on your current income, employment history, and outstanding debts. Often, lenders will use the debt-to-income (DTI) ratio to get a sense of your capacity to take on more debt. To calculate your debt, add up any regular bills including rent or mortgage, credit card payments, loan payments, and education bills; to calculate your income, find your gross monthly income (what you are paid before taxes are removed). Dividing your debt by your income provides your DTI — and typically lenders prefer to see your DTI below 40% before they will consider offering you additional lines of credit.

Capital

The amount of money you put toward your loan or your down payment represents a contribution of capital. While a down payment can reduce the amount you owe on your loan, driving down your monthly payments and interest rates, it also acts as a security for prospective lenders. When you can provide capital in advance of a loan or line of credit, your lender can more easily assign approval.

Collateral

Assets that the lender can repossess — like your car — if you default on a loan provide another security against your potential default. By providing collateral, you significantly lower the lender's risk, which improves your chances for approval. Collateral can also drive down interest rates on the line of credit.

Even if you have a good credit score, some factors may suggest to a lender that you are not able to repay the loan that you are applying for — even with a credit score of 800, your current job with a salary of $75,000 wouldn't suggest that you could pay off a million dollar loan, right?

How to check your credit score

Although your credit score isn’t the only factor that shows lenders your ability to repay a loan, it can help determine whether or not you get approved. You can check your credit score for free before applying for a loan to see whether you may qualify.

Many credit card companies give cardholders free access to their credit scores. If you have a credit card, this is an easy way to check your score. There are also many websites, like Experian and NerdWallet, that will let you view your credit score for free once you create an account.

How to Improve Your Credit Score

Improving your credit score can help you get approved for the loans and credit cards you want. Here are some ways to boost your score:

  • Make on-time payments: Payment history has the biggest impact on your credit score, so making consistent on-time payments can help boost your score over time. Try to make at least the minimum payments on your debts each month and avoid making late payments as much as possible.
  • Lower your credit utilization ratio: Your credit utilization ratio, or the percentage of available credit you’re using, is another important factor that affects your credit score. You should aim for a credit utilization ratio below 30%, since maintaining a lower balance can help you improve your credit score. You can do this by paying off your balances in full when you can and asking your credit card company for a credit limit increase.
  • Dispute any errors on your credit report: Errors on your credit report can be unnecessarily weighing down your credit score. You can check your credit report for free once annually from each of the big three credit reporting bureaus: Experian, Equifax, and TransUnion. If you spot an error, you can dispute it with the credit bureau. This can be a quick way to increase your credit score.
  • Keep old credit lines open: A longer credit history can have a positive impact on your credit score. Consider keeping an old credit card open and making small payments on it occasionally. Closing old credit accounts can decrease the length of your credit history and lower your score.

Know Your Ability To Repay A Loan

When you build a budget, you can find out exactly how much money you could potentially put towards a loan each month. If your budget says that you can't afford the monthly payments, you should avoid applying for a loan or a line of credit.

A lender stays in business by offering the highest amount of loans to those that lenders can be assured will repay the entire loan. Your credit score and other factors may tell lenders that you can take out a bigger line of credit than you actually need — pushing their risk on you. Instead of taking the maximum of what is offered to you, consider first what you can afford to repay each month and build your loan or credit application around your terms, not theirs. You stay in business only by accepting loans that match both your needs and your available funds.

By practicing careful consideration when you apply for a loan or line of credit, you are ensuring that your future credit history is only ever populated by safe bets and comfortable credit.

You Don’t Need A Good Credit Score To Get An Advance America Loan

If you don’t have a good credit score, you can still get approved for an Advance America loan. We accept borrowers with all levels of creditworthiness, so you may be able to get a loan from us even if you have poor or fair credit. Learn more about our payday loans, installment loans, title loans, and lines of credit by visiting Advance America today.

 

Sources:

http://www.qualifiedmortgage.org/ability-to-repay

https://www.score.org/resource/6-cs-business-credit

 

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