Understanding the 3 C’s that Define Credit – Character, Capacity, & Capital

Your credit score is an algorithmic calculation that quantifies whether a person qualified and trusted to manage and use credit. It does this by analyzing and evaluating various factors and influences – at many levels and from a variety of sources.

Bankers and attorneys will explain that a credit score is the quantifiable determinant of one’s creditworthiness. Can they trust you to pay back loans or stick to payment plans? 

A credit score is a predictive tool that assesses an applicant’s financial integrity. There are many reasons for consumers to maintain an awareness of their credit score and understand the essential ingredients that combine to create one’s credit score. If you need/want to delve into your credit history and report, begin by requesting a free credit score.

According to Experian.com, the average credit score (for FICO Scores in the 2nd-quarter of 2019) for consumers in the United States is 703. Additionally, the survey also noted that the average FICO score for Americans has been increasing over time.  

Proactively managing one’s credit is an important component of maintaining a viable credit profile that offers you, the consumer, the best possible financial deal. A recently released report –the 10^th Annual Credit Score Survey (a joint effort of the Consumer Federation of American & Vantage Score Solutions September 2020) – concluded, with great concern, that too many American consumers lacked sufficient knowledge regarding the impact a credit score may have on their lives.

The results from this 2020 survey reveal alarming correlations between a consumer’s lack of knowledge and their household income – with lower-income households possessing less knowledge about credit overall- even though lower-income households were more likely to seek credit! Additionally, the survey also disclosed these striking statistics –

• Nearly half of the respondents of this survey believed their age impacted their credit score. Note – The age of one’s credit items may impact the score, but the consumer’s age is not part of the analysis.
• Only one-third of respondents understood that a credit score indicates one’s likelihood of defaulting on a credit obligation; some even thought it was a measure of one’s knowledge of credit.
• Only 50% of the respondents understood that a utility company – like an electric company – will include a consumer’s credit score when determining if a deposit is required and the amount required.

The reality is, lower credit scores can (and do) increase finance expenses (interest and other fees) associated with many purchases/refinances – in terms of hundreds, if not thousands of dollars.

Exploring the 3 C’s of Credit

At its broadest level, a credit score is based upon three fundamental factors known as the three C’s – Character, Capacity, and Capital.

Character

The concept of character is a direct reference to a measure of one’s trustworthiness.

One’s credit history, and therefore their result credit score, delineates the ways in which the consumer has managed their credit and obligations in the past. Lenders seek to determine how previous credit behavior defines a consumer’s honesty and reliability– hallmark tenets of character.

Capacity

The term capacity is indicative of a consumer’s ability to meet their financial obligations – today and in the future. A consumer demonstrates capacity by answering questions, in part, like –  

• Have you recently graduated from school or a training program? If yes, this would indicate a viable ability to increase wages over time.  
• How long has your current employer employed you? Job longevity is typically indicative of a stable ability to meet repayment obligations.

Capital

The concept of capital refers to a consumer’s ability to offer up an asset (a home, a car, jewelry, a stock portfolio, etc.) that performs as collateral – should the monies borrowed not be repaid as agreed. Collateral offers lenders a strong guarantee of repayment when compared to uncollateralized financing.

The Take-Away – Use Credit Wisely & Stay Informed

A higher credit score indicates to a creditor or lender that a borrower will be less likely to default on debt. As this reduces a lender’s risk, a lender can offer reduced interest rates (to higher credit scoring applicants) as they no longer have to compensate for the higher risk of default by increasing the return on investment.   

Average credit scores vary and increase with age as follows, which is not surprising when one considers that older consumers have likely made mistakes that younger consumers have yet to encounter.

• • Aged 60 years old or older – this group’s average FICO score was 749.
  • Aged 50 to 59 years old – this group’s average FICO score was 706.
  • Aged 50 to 59 years old – this group’s average FICO score was 684.
  • Aged 50 to 59 years old – this group’s average FICO score was 673.
  • Aged 50 to 59 years old – this group’s average FICO score was 662.

Consumers would benefit from increasing their knowledge to understand –

• How a consumer’s credit score is calculated and how to improve their credit score.
• The difference between bad debt and good debt – good debt being tuition payments and bad debt, referring to impulsive purchases bought on emotion rather than sound financial analysis.
• The importance of judicial management of current obligations and available credit.
• How to access a free credit score.