Credit Risk: How Creditors Are Evaluating You | Capital One (2024)

July 27, 2023 |5 min read

    Credit is at the center of many major financial transactions, from securing a mortgage to financing a car or getting approved for a credit card. And from a lender’s point of view, whether to loan a person money or extend credit comes down to risk.

    Learn more about how creditors use information like credit reports and credit scores to assess a borrower’s credit risk, make lending decisions and decide on loan terms.

    Key takeaways

    • Credit risk assesses the likelihood that a borrower will pay back a loan.
    • Credit risk is a factor in lending decisions.
    • Credit risk is determined by various financial factors, including credit scores and debt-to-income (DTI) ratio.
    • The lower risk a borrower is determined to be, the lower the interest rate and more favorable the terms they might be offered on a loan.

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    What is credit risk?

    Credit risk measures how likely a borrower is to pay back a loan—whether it’s a mortgage, a personal loan or a credit card. Lenders consider a potential borrower’s credit risk to inform the decisions they make before extending them a line of credit. And in many cases, lenders use information like the applicant’s credit history and DTI ratio to assess credit risk.

    Generally speaking, borrowers with higher credit scores are considered less risky to lenders. They may be viewed as more likely to pay back a loan on time and in full, so they are more likely to receive the loans they apply for. This is also why less-risky borrowers tend to receive better interest rates, oftentimes resulting in a lower overall payment on a debt.

    Factors that impact a borrower’s credit risk level

    Lenders might consider the 5 C’s of credit—character, capacity, capital, collateral and conditions—when assessing a potential borrower’s credit risk. Here are a few other key factors that lenders might look at before backing a loan:

    Credit scores and credit history

    A credit score is a numerical rank—typically from 300 to 850—that reflects how likely a borrower is to pay back a debt.

    There can be a lot to it, but credit bureaus—like Experian®, TransUnion® and Equifax®—compile credit reports. And the information in those reports is used by credit-scoring companies—like FICO® and VantageScore®—to calculate credit scores. Because there are various credit reports and scoring models, borrowers have more than one score that lenders might use.

    According to the Consumer Financial Protection Bureau (CFPB), credit scores take into consideration a few of the following factors:

    • Payment history
    • Current outstanding balances and debt
    • Amount of available credit being used, or credit utilization ratio
    • Length of time the accounts have been open
    • Derogatory marks, such as a debt sent to collection, a foreclosure or a bankruptcy
    • Total debt carried

    DTI ratio

    Creditors may also evaluate a borrower’s DTI ratio to determine their overall credit risk. The DTI ratio refers to the amount of a borrower’s income that goes toward paying debt. Lenders will look at a borrower’s front- and back-end DTI ratios when assessing credit risk.

    The front-end DTI ratio is the calculation of the borrower’s housing expenditures, like mortgage payments, monthly rent or homeowners or renters insurance premiums. The back-end DTI ratio includes the borrower’s housing expenditures plus any other monthly debts.

    Lenders typically recommend maintaining a front-end DTI ratio that’s less than 28% and a back-end DTI ratio that’s less than 36%. A lower DTI ratio can show creditors that a borrower can take on additional monthly payments. You can calculate your personal DTI ratio by dividing all your monthly obligations by your total gross salary.

    Collateral

    Collateral refers to assets—like real estate or a car—that can be used to back a loan.
    When it comes to secured loans, collateral might be part of a loan agreement. One example is a house as part of a mortgage. Unsecured debt—like credit cards or student loans—isn’t backed by collateral.

    When it comes to credit risk, collateral might be a factor in assessing risk. That’s why when comparing secured debt versus unsecured debt you may find that secured loans tend to have lower interest rates than unsecured loans.

    Benefits of having a low credit risk

    Having a lower credit risk can help a borrower get approved for a loan more easily. Borrowers with a higher credit risk may have a longer approval process before a determination can be made.

    Being a low-risk borrower also means interest rates may be lower on certain loans, like a low fixed-rate mortgage. This can keep more money in a borrower’s pocket over time, which is just one of the many benefits of having high credit scores and a lower credit risk.

    Credit risk can also influence things like credit limits, or the total amount of available credit extended to a borrower by a lender.

    Ways to improve your credit risk

    Credit scores are one indication of credit risk, so making an effort to improve your credit scores can help. Here are some ways you might be able to boost your scores and lower your credit risk:

    • Pay your bills on time, every time. Credit-scoring models typically take into account the timeliness of monthly payments when calculating a score. Paying bills on time every month can help you avoid a late fee and improve your score.
    • Monitor credit scores. Monitoring your credit scores can help you better understand where you stand and stay up to date on any changes made to your report. You could use a free tool like CreditWise from Capital One to monitor your credit.
    • Start building credit early. A long credit history proves your trustworthiness as a borrower. Those looking for a card with easier approval odds can consider opening a secured credit card. Making on-time payments each month can help you avoid accruing interest while keeping a low credit utilization ratio.
    • Maintain a low utilization ratio. Lenders also evaluate the amount of available credit you have when assessing your risk. According to the CFPB, keeping your credit use below 30% shows potential lenders you’re managing your balances responsibly.

    Credit risk in a nutshell

    Before securing any type of loan, creditors will evaluate credit risk to determine eligibility and loan terms. To assess this risk, most lenders take into consideration things like a borrower’s credit scores, DTI ratio and total debt.

    With that in mind, it’s important to build and maintain strong credit scores. One way to help improve or safeguard your scores is through consistent credit monitoring.

    CreditWise can help. It provides your VantageScore 3.0 credit score and monitors credit reports from TransUnion and Experian, two of the three major credit bureaus. CreditWise is free for everyone—whether or not you have a Capital One card—and using it won’t hurt your credit scores.

    And you can get a free copy of your credit reports from each of the three major credit bureaus by visiting AnnualCreditReport.com.

    Credit Risk: How Creditors Are Evaluating You | Capital One (2024)

    FAQs

    Credit Risk: How Creditors Are Evaluating You | Capital One? ›

    Credit risk is determined by various financial factors, including credit scores and debt-to-income (DTI) ratio. The lower risk a borrower is determined to be, the lower the interest rate and more favorable the terms they might be offered on a loan.

    How does Capital One determine credit worthiness? ›

    When pulling your credit reports, they'll look at the details of your payment history and how much you've borrowed. They'll also check for negative information like late payments, foreclosures and bankruptcies. Lenders may also set minimum credit score requirements.

    How do creditors evaluate your credit worthiness? ›

    Lenders assess your creditworthiness by taking into consideration your income and looking at your history of borrowing and repaying debt. Experian, TransUnion and Equifax now offer all U.S. consumers free weekly credit reports through AnnualCreditReport.com.

    What do you mean by credit risk how you manage your credit risk? ›

    Credit risk refers to the probability of loss due to a borrower's failure to make payments on any type of debt. Credit risk management is the practice of mitigating losses by assessing borrowers' credit risk – including payment behavior and affordability.

    What 3 factors do creditors use to evaluate people applying for credit? ›

    Many types of credit are available to consumers in the United States today. Credit can be individual (based on one person's assets, income, and credit history), or joint (based on the assets, income, and credit history of both applicants).

    How accurate is Capital One credit score? ›

    CreditWise gives you an accurate representation of your credit health, as it sources your credit information directly from your TransUnion credit report and updates your VantageScore® 3.0 credit score as often as daily.

    How do creditors judge your character? ›

    Lenders periodically review different factors: your overall credit report, credit score, and payment history. Your creditworthiness is also measured by your credit score, which is a three-digit number based on factors in your credit report.

    What traits do creditors consider when deciding if you are a good credit risk? ›

    Your income and employment history are good indicators of your ability to repay outstanding debt. Income amount, stability, and type of income may all be considered. The ratio of your current and any new debt as compared to your before-tax income, known as debt-to-income ratio (DTI), may be evaluated.

    How to evaluate credit risk? ›

    Factors that impact a borrower's credit risk level
    1. Payment history.
    2. Current outstanding balances and debt.
    3. Amount of available credit being used, or credit utilization ratio.
    4. Length of time the accounts have been open.
    5. Derogatory marks, such as a debt sent to collection, a foreclosure or a bankruptcy.
    6. Total debt carried.

    What are the 5 Cs of credit risk management? ›

    Most lenders use the five Cs—character, capacity, capital, collateral, and conditions—when analyzing individual or business credit applications.

    What are the 3 Cs of credit capital? ›

    The factors that determine your credit score are called The Three C's of Credit – Character, Capital and Capacity.

    What is capital credit worthiness? ›

    Capital: Capital is the portion of funds an applicant plans to put toward a loan. A down payment on an asset, like a car or a home, is an example of capital that a lender may consider when determining a borrower's creditworthiness.

    What are the 3 Cs when a creditor evaluates a credit application? ›

    Students classify those characteristics based on the three C's of credit (capacity, character, and collateral), assess the riskiness of lending to that individual based on these characteristics, and then decide whether or not to approve or deny the loan request.

    Which credit score does Capital One look at? ›

    Capital One appears to pull from any of the three major credit bureaus: Experian, Equifax and TransUnion.

    How does Capital One verify income? ›

    The pay stub must be computer-generated, include year-to-date earnings and taxes withheld, contain no alterations, and must have been issued within 40 days of the faxed date. The applicant must have been employed for at least 90-days to include overtime, commission, and bonuses.

    What does Capital One consider to be excellent credit? ›

    Good credit basics

    FICO considers anything between 670 and 739 a good credit score. And VantageScore says good credit scores fall between 661 and 780. Scores above those might be considered very good, excellent or exceptional.

    Does Capital One use FICO or Vantage? ›

    Additionally, Capital One uses VantageScore to power its CreditWise tool.

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