What is creditworthiness and what factors affect it?

What is creditworthiness?

Creditworthiness is the maximum amount you can afford to allocate toward the monthly installments of a new financial obligation. The bank aims to estimate your ability to repay the loan principal along with interest within a specific timeframe. This is how a repayment schedule is created.

Although the general principle is the same, every bank has its own guidelines and a different level of acceptable risk. This is why you might be able to take out a loan for one million zlotys at one bank, but only eight hundred thousand zlotys at another.

However, talking about amounts in the range of hundreds of thousands of zlotys in the context of creditworthiness is somewhat of a misconception. You can have the capacity for both one hundred thousand and half a million zlotys at the same bank. Why? Because creditworthiness is calculated based on your monthly capacity, and the final amount depends on the loan term. Consequently, your creditworthiness will be completely different for a 5-year loan compared to a 30-year loan.

What affects creditworthiness?

The principle for calculating creditworthiness is actually very simple and can be illustrated by the following formula:

Net income - living expenses - debts = maximum installment

This is how every bank calculates how much money you can borrow from them—and, of course, pay back—once you have covered your daily living costs and settled your other financial obligations.

So, if there is only one formula, why does every bank calculate your creditworthiness differently? When offering you a loan or credit, all banks expect to earn money through interest. However, each bank has a different appetite for risk, meaning some only accept the most reliable clients, while others push their safety boundaries further.

How does this relate to calculating creditworthiness? The analysis of your financial capacity is divided into two parts: quantitative and qualitative.

Quantitative analysis is the previously mentioned formula:

• level of earnings,
• monthly living expenses,
• currently repaid debt.

Qualitative analysis is data that helps predict your future behavior in some way.

• Age; although some banks accept loan repayment just before your 80th birthday, most require the loan term to end before you turn 67.
• Marital status; people with families are viewed as more responsible, and a spouse's additional income is always an asset.
• Number of dependents; the more household members there are, the higher the living costs, especially since not everyone is working.
• Employment history; the most common requirements are a minimum of 3 months for a permanent employment contract, 6 months for a contract for specific work or a mandate contract, and 12 or even 24 months for self-employment.
• Profession and position; professionals in public trust occupations may, though not always, receive preferential offers.
• Financial status; If you have assets, the bank knows that in case of trouble, you aren't penniless and unable to pay your debts, although this is more important for other types of loans. In the case of a mortgage... well, as the name suggests, you have a lien on the property.
• Education;
• Credit history; the least important factor.

Earnings and creditworthiness

An absolute requirement for a bank to accept a source of income is its verification. If your boss at a shady company pays you part of your salary under the table, only the official portion of your earnings will be taken into account. All income that is legal, stable, and expected to continue in the future is taken into account.

Due to these criteria, banks do not accept:

• earnings during a probationary period,
• alimony,
• scholarships,
• child benefit payments and childcare allowances,
• benefits,
• housing allowances,
• temporary disability pensions.

You can take out a mortgage for up to 35 years, while the income from any of the items mentioned above will likely end sooner.

Living expenses

Once you know which earnings the bank will take into account, it is time to start subtracting from them. First, your living expenses are determined. You can declare them yourself, but that will likely not change anything. Usually, the bank sets a fixed level based on the number of household members and will not be interested in your personal household budget.

This is both an advantage and a disadvantage. It may turn out that the bank assumes much lower household maintenance costs than you actually incur, which will increase your creditworthiness. On the other hand, if you borrow to the limit, a fluctuation in interest rates could cause your installment to jump to a level you cannot handle. Do not take out the maximum loan just because you can. Realistically assess your capabilities and exercise moderation.

Liabilities and debts

When filling out a loan application, you will need to provide information about your financial liabilities. Answer truthfully and do not try to embellish, because the bank will vet you anyway.

Your creditworthiness will be reduced by every installment you have to pay. Credit cards, overdraft limits, installment plans for equipment, or loans — it makes no difference. Debt is debt. The most effective way to quickly increase your creditworthiness is to pay off current liabilities and close credit cards. Even unused limits lower your creditworthiness, usually by 5%. So, if you have a credit card limit of 10,000 PLN, it is as if you had to pay 500 PLN every month.

So, what would an example of monthly credit capacity look like, assuming you earn 8,000 PLN net, the bank has calculated your household expenses at 3,000 PLN, and the sum of your debt installments is 1,000 PLN?

Net earnings - living expenses - debts = maximum installment

8,000 PLN - 3,000 PLN - 1,000 PLN = 4,000 PLN*

There is one more issue related to debt: DStI, or Debt Service to Income. This indicator determines the ratio of your income to your debt. According to Recommendation S issued by the Polish Financial Supervision Authority, this ratio should not exceed 50%. Simply put, if you earn 8,000 PLN, the sum of all your debt installments should not exceed 4,000 PLN.

That is why a bank should not grant you a loan with a 4,000 PLN installment. After all, you already have 1,000 PLN in other obligations, which leaves you with a borrowing capacity of 3,000 PLN. Unless you are able to pay off your other debts before submitting your loan application. You have surely grasped how this works by now.

Now you know how creditworthiness is calculated and what affects it. Once you determine your monthly capacity, simply multiply it by the number of years for which you are taking out the mortgage, and you will get the actual amount everyone refers to when they hear the term: creditworthiness. But for how many years should you take out the loan? You will find that out in the next article.