We hear a lot about the importance of credit scores these days. Most people over the age of 25 could tell you their score off the top of their head. People work hard to build their credit because they know it is the key to qualifying for credit. However, your credit score is not the only factor. People with good credit are turned down for a loan from time to time. Read on to find out why.
But what exactly is a credit score and what is it based on? Beyond that, why do people with good credit get turned down for a loan?
Well, just like love isn’t always enough to make a relationship work, having a good credit score isn’t always enough to get approved for a loan. It turns out there’s a lot more that goes into it.
Below are six reasons why borrowers with excellent credit are still refused a loan.
How is your credit score determined?
Below are credit score ranges, according to Experian.com:
- 300-579 = Very Poor
- 580-669+ Fair
- 740-799=Very Good
To determine what range you fall within, your credit score is created based on the information from these five major categories:
- Payment history
- Amounts owed
- Length of credit history
- New credit
- Types of credit in use
This all seems very straight forward. You have a number and a ranking, which will determine whether or not you can receive a loan. But it’s not that simple.
Sometimes, people with good credit scores can still be turned down for a loan. Here are six reasons why.
1) Your income matters
You may have a good credit score, but if your income is low, shaky, or nonexistent, you’ll have trouble getting a loan. Some lenders have specific income requirements that borrowers must meet to qualify for a loan.
Requirements vary from lender to lender but understand that if you’re unemployed, you will most likely be denied.
2) Using too much of your credit already
Jacklyn Shapiro, Co-Founder & Managing Partner of Shapiro Hurst & Associates, LLC, a credit counseling service in Texas, explains, “The number one reason for getting turned down for a loan when you have good credit is utilization ratios and bankruptcy scores run by banks, credit card companies, and other lenders.
There is an algorithm, very similar to the one that calculates our credit scores, that is called a bankruptcy score (it’s one of the eight secret credit scores). When you hit a utilization rate of 64% inside your credit reports, the likelihood of you being in financial trouble and declaring bankruptcy rises.
The bankruptcy score is designed to catch and calculate this. You can still have a good credit score with a higher utilization rate, but when a bank sees a credit report with high utilization, it can cause a denial of credit.”
Think of it this way: A bank looks at all of the bills you are already committed to paying, including credit card debt, student loans, a mortgage, and car payments. If the amount you owe each month is already high, banks may be more wary to give you another loan.
3) Debt-to-income ratio
Credit utilization also affects your debt-to-income ratio (DTI).
Joe Pendergast, VP of Consumer Lending for Navy Federal Credit Union, says: “Beyond looking at a credit score, lenders also consider things like the loan amount being requested, debt-to-income ratio, and collateral, if applicable.”
Your DTI looks at how much you spend each month on debt and compares that number to your monthly income. If your DTI is over 40%, then you are considered a risk to lenders.
4) Bad marks in your past
Maybe you’ve got a great credit score right now, but your past credit is marred by late payments, collections, and perhaps even bankruptcy.
It’s not really fair — America is supposed to be the land of second chances, after all — but some banks will look back further than the typical seven years, and if they see something they don’t like, they can deny your loan.
However, some lenders will consider borrowers with bad credit or a less-than-stellar credit and income history. Note, these loans are typically more expensive and, therefore, should only be used in emergency situations.
5) Debt on the rise
If you’ve been accumulating your debt at a rapid pace, some banks may see this as a mark against you and a possible indicator of future bankruptcy. Also, some banks have restrictions based on how many times you applied for credit during a set amount of time.
Maybe you have a great score, but your report shows you’ve applied for credit five times in the past three months. This alarms many lenders and may cause them to deny you a loan.
6) Too much debt
Some lenders will balk if you have too much debt, despite a good score and a decent debt-to-income ratio. They see your heavy debt load and won’t want to take the risk. This is called the Unsecured Exposure Rule.
How to improve your chances
The best way to avoid credit denials is to only apply for a loan when you’re preapproved. SuperMoney’s loan offer engine allows you to see what rates and terms you prequalify for without hurting your credit score.
Pendergast says, “Your first step should be to review your credit history and score. The focus should be on reducing debt and paying bills on time. Managing your finances responsibly and consistently are the best ways to improve your credit situation.”
Consider asking the lender why you were denied, and, if possible, work on improving that aspect of your credit, spending habits, or employment.
Click here for a list of the best credit reporting agencies, so that you can review your credit report today.
Then, check out our money management reviews page, which includes a list of the top personal finance apps to help you manage your finances effectively.