Credit Score vs Creditworthiness: What's the difference?
I've been writing a lot about credit scores lately. There is just so much to talk about! Chances are if you are reading this article, you are thinking about how to improve your credit score, perhaps because you want to get a loan. So you may also be getting to know a few terms, like "hard inquiry, credit score and wait what?! What is creditworthiness?!
Creditworthiness is essentially how attractive you are to a bank as someone to lend money to. It will definitely take your credit score into account. It will also include things such as your income, balances of your current lines of credit, your repayment history on things like Afterpay, and your savings history.
For instance, your credit score may be average, due to not having many loans in the past, but if the bank can see you have consistently saved $200/week for the past 2 years, they will see you as more credit worthy.
Before we get too far, let's discuss each of these points in detail
This one is pretty self explanatory. In order to lend to you, banks want to make sure you have enough income to pay it back. In addition to the amount, they will look at how long you have been with your current employer and any additional income you earn.
Do you get bonuses on top of your regular wage? Banks will want to see this regularly for 12 - 24 months before they will count it towards your income.
Do you run a business? You will have to provide evidence such as invoice ledgers or Business Activity Statements to prove your turnover.
They will also look at your expenses to calculate what they call affordability. What is affordability you ask? It is the percentage of income you have left after taking out your expenses. The bank or lender will subtract your expenses and the estimated repayments from your income. The amount left over, expressed as a percentage of your original income is referred to as your affordability. Here is a handy diagram:
The percentage of affordability to get a loan depends on the lender. Some lenders will go as low was 10%. On a $400 income that only leaves $40 left over each week! Lenders are not terribly transparent about this process, or what kind of affordability criteria they have internally. Generally, the higher the amount, the higher the percentage of affordability they will require.
Before giving you a loan, especially a mortgage, banks will look at how much savings you have in your account. They may even use the term genuine savings. The first time I heard this, I was shocked! Genuine savings, as opposed to what?
With many Australians getting their super out in a lump sum in 2020, banks will be looking to confirm whether your savings have been accumulated over many months of scrimping and saving, or have been delivered to your account as a lump sum in the form of a super withdrawal, redundancy or inheritance.
If your savings are not genuine, the bank will view you as less creditworthy and may not lend you as much money.
A lender will take into account what assets you have when deciding your creditworthiness, particularly for a secured loan. For example, if you are applying for a $5000 secured loan, and your car is worth $2000, you may not be as creditworthy as someone whose car is worth $5000. This is because your asset is not enough to cover the amount of the loan.
When applying for a mortgage for a second property, they will also take into account the value of your current home.
A lender will take into account any debts that you currently have outstanding. This includes both the balance and the repayment amount. These are the kinds of debts they will ask about:
Revolving Debts (store cards and Buy Now Pay later services)
They may not care too much about the current balances, except to see when they will be paid off. They will care more about the total repayments you are making. They will compare this to your income and assess your affordability. If too much of your income is allocated to paying off debts, you will be classed as over-committed. This will definitely affect your ability to get a loan, no matter how good your credit score is. That is the fundamental difference between credit rating and credit worthiness.
Current lines of credit
This is where Afterpay may be your downfall! Your Afterpay balance may not be large. After all, the limit is usually only $1000! But if you use it a LOT, lenders will be able to see it on your bank statement. They may decide you are less creditworthy if you are consistently racking up big Afterpay bills, so be careful!
Defaults on your credit file last for up to 5 years. This is bad news for your credit score, but it is not the only thing that lender will look at. When you apply for a line of credit, most lenders will ask for your bank statements. They will be able to see any dishonoured payments and rejected direct debits. Too many of these will reduce your creditworthiness. If you are dishonouring payments to other creditors, it makes sense that your payments to a new line of credit may dishonour also. So, even if your credit score is ok, a lot of recent dishonours will be bad news if you are looking for a loan.
Believe it or not, your age may be a factor when banks consider lending to you. I have a friend who tried to buy a house on his own in his late forties after a divorce, and he had a hard time getting a mortgage due to his age. After all, if the loan term was 30 years, they might have found themselves doubting his ability to pay it back before retirement. While this is a bit of a yikes moment, and may not be the case with all people, it is something to consider when buying a house later in life.
What Can I Do To Increase My Creditworthiness?
There are certain factors about your creditworthiness that are out of your control. You can't help your age or income, for example. However, if you are looking at applying for a loan in the next 3 months, make sure your bills are paid on time, your direct debits are clearing, and you are putting a little money aside each week. This will make lenders look more favourably on your application.
If you are interested in different ways to get on top of your budget, have a look at our article about different types of budgets. A good life start with a good budget!