In life, we often determine the worthiness of a thing we wish to get before making our final decision. We determine if it would be a worthwhile purchase, ensuring that whatever we invest in meets our basic criteria. Similarly, banks and Non-Banking Financial Companies (NBFCs) evaluate your creditworthiness when you apply for a loan. If you want to apply for a Personal Loan, here’s what you should know about creditworthiness evaluation.
What Does Creditworthiness Mean?
Creditworthiness refers to your ability to get a loan based on your credit history, financial background, and more. It is measured through a credit score, which is denoted by any number between the range of 300 and 900. The higher the score, the better it is for the borrower.
Borrowers with a low credit score are considered high risk by lenders. As a result, they incur a high-interest rate on their loan. On the other hand, borrowers with a credit score of 750 and higher receive better interest rates on their loans. This further leads to lower EMIs. You can always use a Personal Loan calculator to determine your EMIs.
How Do Financial Institutions Evaluate Creditworthiness?
Banks and NBFCs evaluate the creditworthiness of borrowers using mainly 5 factors, i.e., the 5 Cs of credit. Let’s see what these are and how they determine your creditworthiness.
- Character – The first in the list is the character, which refers to the borrower’s profile. When you apply for a Personal Loan, lenders evaluate your personal as well as financial background. They also consider your credit history which allows them to evaluate your credit risk as well.
- Capacity – Capacity refers to the ability of a borrower to repay a loan or debt. You should be able to repay the loan amount that you’ve borrowed from a lender within the stipulated repayment tenure. The best way to measure this is through the debt-to-income ratio (DTI). DTI is calculated by adding the total monthly debts and dividing that by the borrower’s gross monthly income.
- Capital – Lenders check capital to determine the overall ‘wealth’ or financial strength of a borrower. This is used to establish if you have enough capital to repay a loan in case of a financial stress. This also allows lenders to check if you have alternate sources of funding to pay back your loan.
- Conditions – Conditions are internal and external factors that could pose any level of threat, risk, or opportunity for a borrower. These also refer to the general conditions of a loan for a borrower like duration of employment, job stability, etc.
- Collateral – Collateral refers to an asset held by a borrower that can be put up as security against an Instant Personal Loan. For lenders, it is a form of risk mitigation in case the borrower fails to repay the loan on time. These are usually required with secured loans or when someone is considered a high-risk borrower.
How To Improve Creditworthiness?
- Pay all your dues on time – When you pay all dues on time, such as credit card bills & loan EMIs, it creates a favorable financial image of borrowers among lenders. Doing so can improve your creditworthiness.
- Avoid multiple loan applications – If you apply for multiple loans from different lenders within a short period, it can lower your credit score. As a result, lenders might classify you as a high-risk borrower. Therefore, avoid making multiple loan applications at the same time.
- Maintain a good credit mix – Try to maintain a good balance of secured & unsecured loans. A good credit mix ensures that you come across as a reliable borrower.
- Report & rectify errors in the credit report – Make sure you regularly update your credit report and check for any errors. If there are any disparities, remember to inform the credit bureau immediately to get them rectified.
- Maintain low credit utilization – Avoid any unnecessary spending and only borrow a loan when required. Try to maintain a credit utilization ratio below 30% i.e. your total EMI outgo divided by your total income.
Your creditworthiness is dependent on your ability to maintain a good credit score and pay your debts on time. Simply follow the tips mentioned above to improve your creditworthiness. This will enable you to avail of a Personal Loan at competitive interest rates without any hassle.