by Kailey Hagen | Updated July 21, 2021 - First published on Aug. 13, 2019
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Managing money responsibly is the key to securing new loans. Here are five mistakes to avoid.
Like just about everyone, lenders are protective of their money. They don't want to share it with you unless they believe there's a good chance they'll get it back in the future. So they put all applicants under the microscope. Those with red flags in their financial history are turned away because they pose too great a risk. Each lender has its own risk tolerance, but there are five things that are almost guaranteed to scare off every lender.
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Bankruptcy is the biggest black mark you can have in your financial history, and it's public record, so there's no way to hide it. It stays on your credit report for 10 years, so any lenders you apply to during that time will see it. It's a huge red flag because it shows that you've handled your money irresponsibly in the past and defaulted on your obligations. Even if you're determined to turn over a new leaf, lenders can't be sure of that, so they probably won't work with you just to be safe.
But like all things on your credit report, the effect of a bankruptcy diminishes over time. If the bankruptcy was several years ago and you've demonstrated a responsible payment history since then, you may find the odd lender willing to work with you, though you'll probably pay higher interest rates to account for the increased risk in lending to you.
Payment history is the most important factor in determining your credit score. A single 30-day late payment can drop an excellent credit score by 100 points or more, according to FICO data, and your score could drop even more if the payment is later than 30 days or if you make multiple late payments.
Late payments indicate that you're not keeping on top of your finances and that you could be living beyond your means. Many late payments could indicate someone on their way to bankruptcy. Lenders will often deny these applications rather than risk losing money if you declare bankruptcy later on.
Make sure you always make your payments on time, and set reminders for yourself if you struggle to remember. Contact your lender if you know a payment's going to be late and explain your situation. It may be willing to not report it to the credit bureaus if you've been a responsible payer up until that point.
Your credit utilization ratio is a measure of how much credit you use each month versus how much you have available to you, and it's the second most important factor in credit score calculations. Ideally, your credit utilization ratio should be 30% or less, and the lower the better. So if you have a credit card with a $10,000 limit, you should limit yourself to $3,000 or less per month.
A high credit utilization ratio indicates a heavy reliance on credit. This worries lenders because an unexpected financial crisis could cause you to miss payments, which could set you on that downward spiraling path toward bankruptcy.
Take steps to lower your credit utilization ratio if it's over 30%. Cut down on your use of credit cards or pay your credit bill twice per month if you can. Credit card companies only report your balance at the end of the billing cycle to the credit bureaus, so if you pay the card off part of the way through the month and then again at the end of the billing cycle, you can spend more without raising your credit utilization ratio.
Debt-to-income ratio isn't part of your credit score calculation, but it's something lenders often look at to assess your financial health. It looks at your total monthly debt payments compared to your monthly income. You want this to be 35% or less -- that is, your debts shouldn't take up more than 35% of your monthly income. A debt-to-income ratio higher than this suggests a strained financial situation and a reduced ability to cope with unexpected expenses. This could cause you to fall behind on your monthly payments.
If your debt-to-income ratio exceeds 35%, take steps to pay down your existing debt before taking out new loans. You could also look for ways to increase your income, like starting a side hustle.
Some millennials have decided to avoid credit because they don't want to risk falling into debt. But it's unlikely that you'll be able to afford large purchases, like a home, without borrowing money. Eschewing all forms of credit means you won't have a credit history, so when you apply for a mortgage or another loan, lenders won't have any idea how you'll handle it and they'll probably deny your application.
It's best to have some credit, whether it's credit cards, a personal loan, or an auto loan on your record because it helps you establish yourself as a responsible payer in the eyes of creditors. You may still have trouble securing a loan if you haven't been using credit for long, so try to find a cosigner with a more established credit history to help you.
If you manage your money responsibly and keep your debts to a minimum, you shouldn't have to worry about any issues with lenders. But if you've made any of the above mistakes, do what you can to correct them before you submit your loan application.
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