If you have been denied for a loan, you may not understand why. Remember, lenders are in the business of loaning out their money to you. They make money through the interest rate on the account. If a borrower does not pay back their debt, then the lender takes a loss. To minimize that loss as much as possible, lenders look at certain criteria to determine your credit trustworthiness.
While it is up to each lender to decide the precise criteria for their process, there are several items that they all take into consideration. Your credit score is one of them. There are various types of credit, and each creditor will decide what scores they are willing to extend credit to. In general, a score of 700 is considered good credit, with 750 of higher being excellent. In contrast, anything below a 649 is classified as either poor or bad credit. If you fall into one of these latter two, then it is important to understand why your score is low so you can initiate a plan to improve it before seeking additional avenues of credit.
Interest rates are connected to credit scores. The higher your score, the better you will be. If you have excellent credit, you have proven your ability to manage your debts and so the risk of delinquency or default is less. Lenders are more willing to accept that risk and offer a lower interest rate.
If you have a fair or poor score, be prepared to pay a higher rate on that account. Lenders charge more to those who pose a higher risk of defaulting to offset any losses they suffer from accounts that go into default. Think of it as insurance; everyone pays into the pool for when someone has to use the funds. Not necessarily fair for a borrower with a lower credit score, but lenders have to maintain their return on investments if they are to stay in business.
Lenders need to know how much you make. They need to know you earn enough money to pay back your debt. They will look at your gross monthly income, or the amount of money you receive before taxes are deducted, from all sources to determine your eligibility for a new loan or credit card. They will then subtract taxes, bills, utility payments, and other debt responsibilities to decide if the borrower has the ability to make payments on the proposed account. The more you earn and the less existing debt you have, the better your chances of receiving that loan or credit card (more on Debt to Income ratio below).
Along with income, creditors will also look at your employment history. They want to see a steady flow of income over a period of time. Job hopping, or bouncing from one job to another, over the course of several month (or years, depending on some lenders’ criteria), shows an interruption in income and could indicate an untrustworthy borrower. This will not necessarily deny you the loan, but lenders could require you to pay a down payment before being approved.
Certain lenders and certain types of credit will require a down payment regardless of income. They may also require collateral. For personal loans, you may be asked to put up some form of personal property that could cover the loan should you default on the account. This could include vehicles, large appliances, jewelry, or anything else of value that the lender could sell to recover their losses.
Debt to Income
This refers to how much you owe compared to how much you earn. Lenders use this to determine if you will be able to take on additional debt while paying on what you currently owe.
Take the total amount of your monthly debt and divide it by your gross monthly earnings. This is your DTI ratio. The lower your DTI, the better your standing when seeking new avenues of credit.
Depending on the lender, a ratio of 40% or higher is considered distressed. Those falling within these percentiles are more likely to struggle with repaying a loan; their income is already stretched thin. A ratio within the 30s might have a little difficulty acquiring a loan. Anything 20% or lower are financially healthy and more likely to succeed in opening a new account.
Sometimes we do not understand why we are asked to show identification; why prove we are who we say we are. Lenders need to know who you are so they can verify your credit report and credit scores.
They need to know they are looking at someone else’s information when they are making a loan decision. If there is more than one person with a borrower’s name, the information on your identifying documents can help verify which report is yours.
In the digital age, it is not difficult for identity thieves to get ahold of your private information. To reduce the risk of extending credit to an individual who is not you, and who will never start repaying the loan, various forms of identification are a necessity.
Proof of ID and Employment
The most commonly used form of identification is a photo ID. These can include a state-issued driver’s license, military ID, or passport. This is the proof you are who you say you are.
You will also be asked to show proof of income. This will come in the form of pay stubs, usually the last two you received from a job. Not only do you need to prove you actually work for a company, but you are earning what you claim you do. A W-2 from the previous year, or your latest tax return, may be required for larger loans.
Utility bills are often asked to show proof or residence. These will not only show your current address (if different from what is present on you photo ID), but will also, as mentioned above, help differentiate you from anyone else with the same name.