HOW GOOD IS YOUR CREDIT?

The process that determines your creditworthiness involves three areas of your financial situation, "the three C's":

Capacity

Capacity is based on your income. Your capacity is your ability to make loan or credit card payments. This is critical to your being granted loan or credit approval, especially when applying for a mortgage.

Your debt-to-income ratio is used to determine your capacity. You need to know your total indebtedness to calculate your ratio.

All your available cash and the value of any property you own are considered part of your capacity. This includes all savings, money market funds, investments and assets. This shows creditors that you have other ways to pay your debts besides your income.

• Income stability
• Employment history
• Amount in savings
• Monthly debt payments (credit card bills, car loans, etc.) compared to your income

Collateral

• Land or property
• Other valuable assets

Credit

• Credit history
• On-time payment of mortgage or rent, utilities and other household bills

You must have enough of these three C's for the creditor to take a risk by granting you credit. To review your three C's, creditors ask for a financial statement. This statement gives the creditor a picture of your financial situation and credit history.

Your strength in one area can cancel out your weakness in another. The lender sees the strength as a "compensating factor" for the weakness. For example, if you own a home (strong collateral), but your credit history contains several late payments (weak credit), the lender may not penalize you for your weak credit because you have such strong collateral.

Creditors use these three primary factors, the three C's, to determine whether they should grant you credit. Creditors want to know that you'll pay them back. If creditors can determine that you're worth the risk, then they consider you creditworthy.

Creditors look for ways to help them predict the future behavior of borrowers. They want to minimize their financial risk. Each creditor decides how much credit risk it can afford. Creditors and lenders use computers to measure credit risk.

Creditors evaluate credit risk using a tool called a credit score. Information from your credit report is used as the basis for your credit score.

Your credit score is a computer-generated number. The number predicts how likely it is that you will repay future debt.

The computer summarizes your credit profile and compares it to other profiles to calculate your credit score.

Your credit score takes several factors into consideration, such as payment history and number of credit accounts. Various credit scoring companies use different factors.

Once you understand the credit evaluation process from the lender's perspective, you can increase the odds that you'll be granted credit.

Creditors consider the three C's – capacity, collateral and credit – to determine your creditworthiness. Creditors and lenders use computers to measure credit risk.

Just remember to think like a lender. Be smart with your money, and you can build a good credit history.