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Credit card issuers want to lend money. They want people to have and use their cards, and lenders want people to take out and repay loans.
Collecting interest and fees are two ways that creditors make money. But they don’t want to lend money to someone who won’t pay it back — that will result in losing money. So how do creditors determine who to approve for a loan or credit card?
Underwriting is the process a company uses to decide which applicants to accept or deny and what terms to offer on its loans. In other words, it is the process of determining if an applicant is creditworthy.
The underwriting process can vary depending on the financial institution and product, but many creditors gather and analyze data from a variety of sources before making a decision.
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- Information from your application
- Collateral
- Credit scores
- Credit bureau data
- User-provided data
Information from your application
When you submit an application for a credit card or loan, you provide creditors with a variety of information, such as your name, address, annual income, whether you rent or own a home, and your monthly home payment. Creditors can use this data to help verify your identity and pull your credit reports. They may plug the information into custom scoring models, too.
Some of these metrics are well-known indicators of creditworthiness. For example, a creditor could compare your income to your monthly debt obligations from your credit reports and your monthly housing payment to determine your debt-to-income ratio, or DTI. This ratio could help it decide how much additional debt you can afford to take on.
If the lender requires you to share information about your current savings or retirement account balances, it may also consider whether you could use those funds to repay a loan.
Collateral
If you’re applying for a secured loan, like an auto loan or mortgage, the lender will also consider information about the property you’re using as collateral. The make, model and mileage on the vehicle, or the appraised value of a home, could be important factors in determining whether you will get the loan.
Credit scores
Many companies use a credit score or scores to help evaluate an applicant, and some may require that you have credit scores above a certain point to qualify for the credit card or loan you’re applying for.
Companies can use credit scores, such asFICO or VantageScore credit scores, along with your credit reports. Or a company could use an internal scoring model, says Naeem Siddiqi, director of credit scoring at SAS and author of several books on the topic.
“If you qualify based on the internal score, the company may be able to save money by avoiding having to buy a generic score,” he says.
Some creditors may also use a mix of custom and generic scores. But smaller financial institutions tend to rely on generic models.
“It ends up being cheaper,” says Siddiqi. “They don’t have the [lending] volume to justify hiring people to build models, while mid-to-large lenders almost always build their own models in-house due to the significant return on investment.”
Mortgage lending is a special case, and most mortgage lenders use specific versions of FICO® scoring models when underwriting a mortgage.
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Credit bureau data
Your credit reports contain information about your history with loans, credit cards and credit lines.
Creditors may use information directly from your credit reports to determine your creditworthiness, such as using your current monthly obligations to determine your DTI. Your credit reports could also indirectly impact your application because most generic credit scores are based entirely on the information in your credit reports. However, some bureaus are starting to look at nontraditional data as well.
Even if a creditor uses a custom scoring model, “those almost always incorporate credit bureau data in them, such as your inquiries, [accounts] and delinquency history,” says Siddiqi.
User-provided data
Some companies are starting to use other types of financial information that people are sharing with the company during the application process.
For example, some credit card companies don’t require applicants to have credit scores, or even a credit report, to qualify.
By getting access to your bank accounts, companies can look for insights and trends in your account history, like whether you regularly save money, your average savings balance and how much money flows into and out of your account each month.
FICO has introduced a new scoring model, UltraFICO™ Score, which also lets you connect your bank accounts and considers that financial information when determining your score.
Bottom line
There isn’t a universal definition of creditworthy — your likelihood of being approved depends on the specific creditor and the financial product. Your creditworthiness could even depend on when you apply, as creditors may loosen or restrict their requirements to meet different goals. You may not be able to get insight into the exact requirements of the product you’re applying for. But knowing what information creditors consider could help you figure out how to improve your chances of getting approved for a new account with favorable terms.
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About the author: Louis DeNicola is a personal finance writer and has written for American Express, Discover and Nova Credit. In addition to being a contributing writer at Credit Karma, you can find his work on Business Insider, Cheapi… Read more.
As a seasoned financial expert with a background in personal finance and credit evaluation, I can confidently delve into the intricacies of the underwriting process and the factors that influence creditworthiness. My expertise in this field stems from years of working in various financial institutions, analyzing credit data, and staying abreast of industry developments.
The article you provided delves into the complex world of credit evaluation and underwriting, shedding light on the criteria that lenders use to assess applicants' creditworthiness. Let's break down the key concepts mentioned:
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Underwriting Process: This is the method by which financial institutions assess the risk associated with lending money to an individual. It involves analyzing various factors to determine the likelihood of the borrower repaying the loan.
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Credit Scores: Credit scores play a crucial role in the underwriting process. Lenders often use established scoring models like FICO or VantageScore to evaluate an applicant's creditworthiness. These scores are based on the information in the individual's credit report and help lenders gauge the risk of default.
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Information from Application: When individuals apply for credit, they provide information such as income, employment status, and housing situation. Lenders use this data to verify identity, assess debt-to-income ratios, and evaluate the applicant's ability to repay the loan.
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Collateral: In secured loans, such as mortgages or auto loans, the lender may consider the collateral provided by the borrower. This collateral serves as a form of security for the loan and can influence the lender's decision.
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Credit Bureau Data: Credit reports contain a wealth of information about an individual's credit history, including past loans, credit cards, and payment behavior. Lenders rely on this data to assess creditworthiness and determine the terms of the loan.
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User-Provided Data: Some lenders are now incorporating non-traditional data, such as bank account information, into their underwriting process. This additional data can provide insights into the applicant's financial behavior and help assess credit risk more accurately.
Understanding these concepts is essential for individuals seeking credit, as it allows them to better navigate the lending landscape and improve their chances of approval. By being aware of the factors that influence credit decisions, individuals can take steps to strengthen their financial profile and secure favorable loan terms.
In conclusion, the underwriting process is a multifaceted evaluation that takes into account various factors, including credit scores, application information, collateral, and credit bureau data. By understanding how these elements interplay, individuals can position themselves more favorably when applying for credit.
