Creditworthiness impacts consumers on multiple fronts. Whether they want to expand their business, purchase a new vehicle, or make updates to their homes, consumers need a way to demonstrate to lenders they are worth the risk of a loan.
Similarly, when lenders extend credit, they want to ensure the loan is likely to be repaid on time. To determine whether or not someone has creditworthiness, they use readily available financial data, like credit scores.
However, credit scores alone don’t provide a holistic view of whether a consumer is able to repay their loan. Instead, many lenders, including fintech and traditional banks, are turning to alternative sources of financial data to assess creditworthiness.
Creditworthiness is an assessment of risk used by lenders to decide whether to extend a loan to a consumer or business. Creditworthiness serves as a framework to determine not just whether lenders are able to offer a loan, but the loan amount and interest rate.
Creditworthiness is calculated using data about consumers' financial history, including debt load and repayment history. For lenders, creditworthiness is crucial to limit risk and ensure profitability. For consumers, being creditworthy can mean the ability to finance a degree, start a business, or even get a job with employers that handle sensitive data.
Why does creditworthiness matter?
For consumers, creditworthiness is important to access lower interest rates and larger loans. People and businesses who are not considered creditworthy may not be able to take out loans to purchase a home or expand their business. For lenders, measuring creditworthiness is important to ensure people who borrow money can pay it back.
How can lenders determine creditworthiness for a customer?
There is no single formula for determining creditworthiness. Rather, different lenders rely on various data points to assess their own risk. While the exact method used to measure creditworthiness varies, most companies look at similar types of data.
Many lenders now consider alternative sources of data to determine creditworthiness, with fintech lenders being the earliest adopters. The most common types of data used to analyze creditworthiness are:
A credit report is a summary of a consumer's or business' credit and repayment history. Three of the largest consumer reporting agencies that provide consumer credit reports are Equifax, Experian, and TransUnion, while business credit reports are provided by business credit bureaus, such as Dun & Bradstreet, Experian Commercial, and Equifax Small Business.
Credit reports include a wealth of data lenders can use to evaluate risk, including past loans, open lines of credit, the number of credit inquiries, debt-to-income ratio, and personal information such as name and birthday. These reports generally do not include information like salary or rent and utility payments.
A credit score is a numerical evaluation used by lenders to determine creditworthiness. Credit scores are between 300 and 850, with 850 considered "exceptional" and 300 considered "poor." Consumer credit reporting agencies use a variety of factors to calculate the credit score, including payment history, amount of debt, how long credit accounts have been open, and amount of new credit accounts.
Unfortunately, each consumer credit reporting agency calculates credit scores differently, making it difficult for lenders to calculate true creditworthiness based on credit score alone. Credit scores may not include recent transactions or may be based on inaccurate data, such as a loan from someone with a similar name. Each credit reporting agency is treating new types of loans, like BNPL, differently, making it even hard to assess creditworthiness purely from one data source.
Repayment history refers to payments made for past debt, including if payments were on time. Most lenders report payment history to credit agencies which use them to calculate credit scores.
Using repayment history essentially requires consumers to take on debt before they can be considered creditworthy. As a result, consumers without a repayment history may not be able to access credit at all. This requirement is changing, however. For example, SoLo, a peer-to-peer lending platform, considers repayment history within the app to determine creditworthiness.
In relation to creditworthiness, collateral refers to assets a lender can seize if a consumer fails to honor the terms of a loan. For example, if a lender finances a car loan, they can seize and sell the car to cover losses if the consumer fails to pay. This data can be used to determine creditworthiness for larger purchases, such as a car or home, or for business loans.
However, relying on this lending data can limit access to consumers who don't qualify to purchase a home or car.
Credit utilization is the sum of all a consumer's debt divided by the sum of their credit card limits. Essentially, this number tells lenders if you have maxed out your current credit lines by measuring your unused credit.
Consumers who don’t utilize the full lines of credit across many cards may be more likely to repay their loans. However, using this metric puts consumers who don't have credit cards at a disadvantage and incentivizes opening multiple lines of credit.
Alternative sources of creditworthiness data
Creditworthiness is always based on data, however, many lenders rely solely on the most accessible sources of financial data, such as credit scores and credit reports. However, nearly a third of Americans have a FICO score of fair or below and, as a result, may have less access to credit.
Other lenders, led by those in the fintech industry, rely on alternative data sources to determine creditworthiness. Alternative sources of data include income, employment information, rental payments, and payment history in peer-to-peer apps.
Using Plaid to connect with banking systems and fintech companies, such as peer-to-peer lenders, provides lenders with a holistic view of a consumer or business' complete financial history, making it easier (and faster) to perform a creditworthiness assessment.
→ Want to verify borrowers’ income and employment faster? Plaid’s Income API provides robust data pulls for employment and income verification in seconds.
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How to determine creditworthiness of a company
Like consumer loans, business loans also require a creditworthiness assessment. However, company creditworthiness is determined using slightly different data.
Most lenders look at financial information such as:
Business credit reports
Increasingly, more lenders are using large sets of business data to analyze business creditworthiness and determine whether to offer a loan and how much to offer.
The data lenders use to assess creditworthiness is changing
When lenders use the same model to assess creditworthiness, it excludes some users from accessing capital. This has a negative impact on both consumers and businesses. Consumers deemed too risky, for example, may turn to less regulated lending sources and end up paying higher interest rates, overdraft fees, and late charges.
Lenders feel the impact, too. When creditworthiness is determined by traditional methods, they have access to fewer customers. Changing how creditworthiness is calculated expands access to lending, which increases revenue for lenders.
For example, Purpose Financial uses Plaid to verify borrowers' assets and income, directly from their bank account. As a result, they can determine creditworthiness in just a few seconds, using unique consumer data. This allows them to offer personalized loans to a larger pool of customers.
→ Want to access transaction history, balance, and account ownership faster? Plaid’s asset verification APIs instantly provide an up-to-date view of a borrower’s bank accounts and assets.
Credit scores don’t give the full picture of creditworthiness
Assessing creditworthiness is a crucial step in the loan process. However, credit scores alone don’t fully determine creditworthiness. Rather, credit scores should be used as one tool in a large toolbox of financial information. Alternative sources of lending data, such as diversified income and spending patterns, are faster and provide a more holistic view of lending risk.
With more data to assess creditworthiness, lenders gain access to a wider pool of customers—and customers gain access to tools and loans they can use to build a better financial future.