by Christy Bieber | June 10, 2019
Your credit score isn't the only factor lenders consider when deciding whether to approve you for a personal loan.
When you apply for a personal loan, you want to maximize the chances you’ll be approved. After all, when you need the money, there’s nothing more frustrating than a lender denying your loan request.
To make sure you aren’t disappointed by a surprise denial, it’s helpful to understand some of the key factors lenders consider when deciding whether to approve you for a loan. Obviously your credit score is one of the single biggest deciding factors because your score provides tons of insight into your borrowing behavior. But it’s not the only thing personal loan lenders look at when making a decision on whether to give you a loan or not.
In fact, a number of other factors besides your credit could affect personal loan approval including your employment history; the amount of income you have; how much other debt you have; whether you’ve been applying for lots of loans; and whether you’re pledging any collateral.
Let’s take a closer look at some of these other factors to better understand how they can impact the likelihood you’ll be able to get a personal loan.
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Lenders don’t want to make loans to people who can’t pay them back. So when you apply for a loan, financial institutions are naturally very concerned about the amount of income you have available to make loan payments.
If you’re trying to borrow for a loan that would have $1,000 monthly payments but your entire monthly income is just $1,500, this is a major red flag to a lender that you’re going to struggle to pay. But if your loan would have payments of just $100 per month and your monthly income tops $5,000, then you stand a much better chance of being approved for a loan since payments make up such a small percentage of what you earn.
For most people, income comes from employment. Lenders want to know whether your work situation is steady or whether you’re likely to lose your job -- and source of income -- at any moment.
Of course, lenders don’t just call up your boss and ask if they’re planning to fire you soon. Instead, they’ll typically look at your recent employment record. If you have had the same job for a year or two, the financial institution will usually consider it a pretty likely bet that you’re going to continue to work with the company. On the other hand, if you’ve only recently gotten a new job or been bumped up to a higher pay grade, lenders may not view this income as very reliable.
When evaluating the amount of income you have to pay back the loan, it’s common for lenders to only consider income you’ve been earning for the past 24 months. So if you earned $50,000 for the past three years but got a raise to $75,000 a month before applying for a loan, lenders will likely evaluate your loan application as if you still made only $50,000. This lower income will determine how much you’re allowed to borrow or if your loan is approved at all.
It’s not just your income that affects whether you’re likely to pay back your loan -- other debts you owe can also make an impact. If you’re drowning in debt already, lenders aren’t exactly going to be lining up to give you yet another loan. After all, if you owe a fortune, any minor drop in your income could leave you struggling to fulfill all of your existing financial obligations.
To evaluate the likelihood of loan payback, lenders compare your monthly debt payments to your monthly income. This ratio is called your debt-to-income ratio (DTI). Different personal loan lenders have different maximum DTIs, but many require your debt payments to be below around 35% of your income. If you exceed the maximum ratio with a particular lender, your loan application will be denied.
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Another red flag for lenders comes when you submit tons of credit applications in a short period of time. If you’ve suddenly gone on a borrowing spree, financial institutions grow very concerned that you’re getting in over your head and that default is likely in your future.
Lenders can see how much credit you’ve recently applied for by looking at the number of inquiries on your credit report. Each time you request credit -- such as by applying for a personal loan, mortgage, or credit card -- a hard inquiry is placed on your report. These inquiries stay there for two years. If you’ve had 10 inquiries recently because you’ve applied for 10 different loans, lenders may be wary of lending to you.
There’s one exception though: You can shop around for loans without getting dinged. In other words, if you have a few inquiries for personal loans all within a few weeks of each other but no new loans have shown up on your credit report, lenders will likely assume you’re just comparing loan rates and terms and you won’t be penalized in the loan approval process.
Of course, if you don’t want to take a chance, you can look for personal loan lenders that don’t require hard inquiries to pre-approve you for loans or give you details about the rate you’re likely to qualify for.
Sometimes you’ll have a lot of factors counting against you that make it hard to qualify for a personal loan -- such as a low credit score, limited income, or a record of many past job changes. While many lenders won’t want to lend to you under these circumstances, some financial institutions offer secured personal loans that can be much easier to qualify for.
With a secured loan, there’s collateral -- such as money or other assets -- that guarantees the loan. The lender has a legal interest in the collateral and it can be seized if you don’t pay what you owe. Since lenders could take the collateral to cover their costs if you don’t pay, there’s limited risk to lenders and loan approval becomes much more likely.
Understanding the factors that lenders consider in making decisions on who to loan money to can help put you in the best situation for approval. By avoiding applying for too many loans and trying to keep your income and employment situation stable, you can maximize your chances of not just getting a loan but also getting approved to borrow at a favorable rate so your loan will cost less to pay back over time.
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