You were all set to buy that new car or house. You may have even picked out the cherry-red convertible or the Cape Cod with the spacious yard -- until your bank stopped you in your tracks. Your loan has been denied, and now you're not sure what to do. It's a pretty common scenario, and unfortunately, there isn't always a quick solution.
But not all hope is lost. Here are a few things you can try to secure the financing you need.
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1. Find out why your application was denied and correct the issues
The first step is always to understand why your loan application was turned down. This can give you some idea of what you have to do in order to get approved. Your bank should send you a letter explaining why it chose to deny your application.
You may have been denied because your credit score is too low. Perhaps you have a lot of debt that you've been struggling to pay off. Or maybe you don't always make your payments on time. These things make creditors nervous about your ability to repay the loan. If you want to increase your chances of getting accepted, you'll have to address these problems, and that can take time. But doing so will not only increase your chances of approval, but also help you secure better interest rates, so it's well worth the time and effort.
If you're perplexed as to why your application was denied, it's a good idea to pull your credit reports and look for anything out of place. For instance, if you see an outstanding debt that you're sure you've paid off, then perhaps that creditor made a clerical error. In that case, give the creditor a call -- with proof of the payment in hand -- and ask to have the account reported as paid.
You should also scan your report for accounts that you don't recognize. If you see an account that you didn't open, then you may be the victim of identity theft. In this case, you need to alert the lender immediately, call the credit bureaus to place a fraud alert on your credit report, and file a report with your local police station. This can take some time to sort out, but once you do, you can reapply for the loan.
Another reason your loan application may be denied is if you don't show enough income. Creditors often look at your debt-to-income ratio when deciding whether to lend to you. If your total debt amounts to more than 30% of your income, it signifies to lenders that you may be living beyond your means. You can correct this by paying down your debt and making sure the creditor has accurate documentation about your income.
2. Use collateral or a cosigner
If you need the money now and you can't fix the issues listed in the explanation letter quickly, then you need to find a way to minimize the risk you pose to lenders. If you were applying for an unsecured personal loan, then you may have better luck offering something up as collateral, such as your car. That way, if you fail to pay, the bank has a way to recoup some of its money. Because of the decreased risk of loss, the lender may be more willing to give you the loan.
Some loans, including mortgages and car loans, already have collateral -- that is, the home or the vehicle they finance. If you're denied one of these loans, then you may have to find a friend or family member who is willing to cosign with you. Their good credit may reassure the bank that the loan will be repaid, because if you fail to pay, the lender can demand payment from the cosigner.
Before resorting to either collateral or a cosigner, you must think carefully about your decision. If you offer property as collateral and then default on your payments, then you'll lose that property and a good chunk of your credit score. If the loan has a cosigner and you don't pay, then you're placing a huge financial burden on the cosigner -- and potentially ruining a relationship in the process. Unless you're confident that you can make the loan's monthly payments, you're better off waiting until you've improved your credit before you apply again.
3. Make a larger down payment
You may be able to increase your chances of approval simply by decreasing the amount of the loan. When evaluating loan applications, lenders look at the loan-to-value (LTV) ratio, which measures the size of the loan compared to the value of the object you're buying. A high LTV ratio represents a greater risk, because there's a chance that the value of the object, if sold, might not be enough to cover the total cost of the loan and provide sufficient profit to make the deal worthwhile to the lender.
Ideally, you can make a down payment of at least 20% of the total value if you're buying a home or car. Lenders usually offer the best rates to individuals who can pay at least this much upfront. Not everyone can afford this, though. In that case, do the math and figure out how much you can reasonably put toward the down payment. Say you were denied a $20,000 loan with a $2,000 down payment. If you can double the down payment to $4,000, you'll have much better odds of approval, because your LTV ratio will spike from 10% to 20%.
4. Apply for a loan elsewhere
All lenders weigh risk slightly differently, so just because you were denied by one doesn't mean you'll be denied by another. Of course, that all depends on why you were denied. If your credit score is under 500, you'll probably have trouble getting a loan anywhere. But if your credit is 680 or better and there aren't any major red flags on your credit report, then it may be worth trying another lender.
If you're going to apply elsewhere, you're better off doing it quickly. Most credit scoring models count all hard credit inquiries that happen within a 30- to 45-day period to be a single credit inquiry, which means they have less of an impact on your credit score. Waiting longer than this will put another hard inquiry on your report and can lower your score.
Getting denied a loan isn't the end of the world, but you need to understand why it was denied and then take steps to correct the problem. By following the four steps outlined above, you should be able to get the money you need without too much hassle.
