At the point in history when lending occurred primarily within families and small communities, many borrowers likely knew their lender — and his or her spouse and children — by name. In those days, your personal creditworthiness likely depended as much on your reputation among your neighbors as it did on your actual financial status.
Today, with millions of borrowers around the country, creditors rely on your credit report to determine your ability (and willingness) to repay a loan or other credit line. Full of information reported by your current and recent creditors, your credit report is often the best resource for potential lenders to learn about your financial habits from those who know them best.
Essentially, the name of the game in consumer lending is risk management, so when looking at your credit report, the lender is trying to determine the level of financial risk you represent. While each lender will likely have its own individual requirements and risk threshold, most creditors will look for the same general information.
Your Payment History
Perhaps the most straightforward indicator of whether you’ll pay your future debts is to look at whether you’re paying your current debts. For that reason, your credit payment history is not only the first thing most lenders will examine on your credit report, but it also represents 35% of your FICO credit score calculation.
The main thing creditors (and FICO) will be looking for when analyzing your payment history is the appearance of any red flags, such as missed payments, or worse, defaulted accounts. Lenders will look at a variety of account types, including credit cards, retail accounts and store cards, installment loans (personal, auto, and student loans), mortgages, and finance company accounts, to get an idea of your ability to repay your debts.
Since your payment history is such an integral part of obtaining future credit, it’s vitally important to avoid late payments, missed payments, and delinquent or defaulted accounts. In the event you can’t pay a credit obligation as agreed, contact your creditor immediately to set up a payment plan or find another repayment option.
If high interest fees are causing you to miss payments, you may be able to refinance your auto loan or mortgage debt at a lower rate. For high-interest credit card debt, consider consolidating your debt with a lower-interest personal loan. You can find personal loans for bad credit from a variety of lenders.
Your Current Debt Profile
Another important aspect of your potential credit risk is the actual makeup of your current debt profile. Lenders will be interested in both the types of debt you have — revolving, installment, etc. — as well as the actual amounts. Ideal applicants will have a variety of account types, showing they can handle multiple credit structures.
More important than the specific types of credit you have, however, is how you are using it. While this starts with examining all of your accounts to determine the total amount of outstanding debt you currently owe, you don’t need to be debt-free to qualify for new credit. Instead, creditors will look just as carefully at how much debt you could have as how much you have now.
For instance, creditors will determine your debt-to-credit ratio for any installment loans, taking into account how much you owe as well as how much you’ve already repaid. For revolving credit lines, such as credit cards, lenders will evaluate your credit utilization rate, which is the ratio of your current revolving balances over your total available credit. Those with low utilization rates, typically 30% or less, will be considered a lower credit risk than those using all or most of their available credit.
While the easiest way to improve your utilization rate is to pay down existing balances, you can also improve your ratio by increasing your available credit. Opening a new credit card can be an effective solution for many consumers, and even those with lower scores can find options from the many issuers who offer cards for poor credit.
The Age of Your Credit Accounts
Although not generally as influential as your payment history and debt ratios, how long you’ve been using credit is also taken into consideration when lenders review your credit report. When considering this facet of your report, lenders will analyze both the age of your oldest account as well as the average age of all your accounts combined.
Overall, the longer your (positive) credit history, the less risky you appear to creditors. In fact, those with the highest credit scores tend to have credit histories averaging more than 25 years old, with an average account age of nearly 11 years.
For the most part, the only way to achieve a healthy credit age is to start establishing your credit as early as possible. It is also a good idea to avoid opening extraneous credit accounts, as each new account will lower your average account age. In addition to lowering your average age, opening new accounts, especially several new accounts in a short period, will signal a red flag to creditors, as it may indicate you will be taking on more debt soon.
Ashley Dull is the Finance Editor at Digital Brands, Inc., where she oversees content published on CardRates.com and BadCredit.org. Ashley works closely with experts and industry leaders in every sector of finance to develop authoritative guides, news and advice articles with regards to audience interest.