Creditworthy is a term used by lenders to evaluate the risk level associated with a person or a business applying for financing. Being more creditworthy means there is less of a risk of defaulting on the borrowed amount or that the lender has less risk in recovering their losses.
Creditworthiness is for both personal and business borrowing on financial products including:
- Loans
- Credit cards
- Lines of credit
- Insurance policies and premiums
- It also extends to renting property, equipment, and assets
The more creditworthy an applicant is, the better rates and terms they’ll get on financial products, and the more likely they are to get approved. While there is no single standardized metric for being creditworthy, there are things that go into how an application is viewed including outstanding debts, financial history, collateral that is offered, money in a personal or business bank account, credit scores, etc.
Each lender and financial institution will use their own metrics, so where one sees you as medium risk, another may see you as low risk. This could be based on their familiarity with your industry, or because of their company’s policies based on risk and NAICS codes. This is why you may get different rates and terms when you apply for financing with different lenders, even though the amount being requested is the same.
If you’re applying for a small business loan, equipment financing, a line of credit, or a mortgage, here are a few ways you can make yourself more creditworthy, and some things to avoid doing so that you don’t lower your chances of getting good rates and terms.
Ways to Improve Your Creditworthiness
When applying for business financing, your personal financial history can come into play. This is especially true if your company is new, if you don’t have a lot of assets, or if your current revenue is not in line with what the lender is looking for. In some cases, your personal finances can be used as a security blanket for the lender, and you may be asked to sign a personal guarantee as an added protective measure to the collateral on the business loan.
Some of the easiest ways to improve your creditworthiness include:
- Clearing debts off of both your personal and business credit scores by looking up what is reported to the three business credit bureaus (Dun & Bradstreet, Experian Business, & Equifax Business) and the three consumer credit bureaus (Equifax Personal, Experian Personal, and TransUnion Personal). If you don’t have access to a free business credit report through a membership or subscription, you can purchase a copy. Then, the goal is to pay down the reported debts as much as possible before applying. Check which bureaus your lender uses to focus on the debts on those reports.
- Open a business bank account with the lender if they offer this as a service in order to show you’re looking for a multi-faceted relationship. The added benefit is that they can access your financials over a long period if you have an account. This builds trust and may help you get approved for future financing.
- Offer a larger deposit or more collateral to offset your risk as a borrower. By giving the lender more assurances in case of default, you reduce their risk which in turn increases your creditworthiness.
- Reduce your credit utilization ratio and debt-to-income ratios. These are measures of how much available credit you use and how much debt you or your company can afford to take on.
- Credit utilization is calculated by dividing your total revolving credit balance by your total credit limits and multiplying it by 100.
- Debt to income ratio can be found by dividing your total monthly debts by your total monthly income and multiplying it by 100 to get the percentage.
- If you opened a new credit card recently but have your old one open and it has a long history of financial responsibility, you may want to keep it open to show your intended lender that you make payments on time.
- A strong business plan with details about growth and contingency plans can go a long way by showing your knowledge of the industry and your responsible use of funds. Make sure to include how you’ll budget for interest payments and where future financing needs like a new business loan may come in. This shows the lender that they may have another opportunity to loan you money in the future if they lend to you now.
- Bring any letters of intent or contracts that will be finalized if you were to gain access to financing. This shows the lender that you will be able to increase your revenue and, when combined with the business plan, it should help your creditworthiness.
There’s no shortage of ways to improve your creditworthiness when applying for financing, but there are things you want to avoid doing.
Things That Lower Your Creditworthiness
To keep yourself lower risk when you apply for financing, try to avoid doing the following:
- Applying for new credit cards, lines of credit, or loans as each one may have a hard inquiry tied to it, and that temporarily lowers your credit score.
- Missing payments to vendors including utilities, suppliers, financial institutions, and anyone else that reports to public records and credit bureaus.
- Making a large purchase in your personal life that could impact your cash in the bank, personal credit score, and finances, in case you’re asked to make a personal guarantee.
- Having business and personal bank accounts or credit cards combined, as this makes it harder to see what assets are available and what can be seized in case of default. The harder the lender has to work, the less creditworthy you may appear.
- Selling assets. Assets that hold value can be used as collateral and increase your creditworthiness. You can always sell them after you pay the loan back, especially if they hold their value.
Anything that would reduce your net worth or that of your company/owned assets, or impact credit scores and debt ratios, will have a negative impact on how creditworthy you are to a lender. Be careful and plan ahead so you don’t accidentally create a situation where you now have a higher interest rate or less favorable terms.
Creditworthiness is a measurement that a lender or financial institution uses to determine how likely the borrower is to make on-time payments and not default. Being more creditworthy increases your chances of getting approved, so it is a good idea to think about ways you can offset the lender’s risk.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
