Personal loans are on the rise. As of March 2019, Americans had $1.49 trillion spread over 19.5 million personal loan accounts (source). That is not to say personal loans are easy to get. Lenders are, once more, tightening credit requirements.
How can you improve your chances of qualifying for a loan?
These financial strategies will improve your chances of getting your next personal loan application approved.
How To Qualify For A Personal Loan?
- Determine what type of loan you need
- Check your credit score
- If needed, improve your credit score
- Match your credit score to a compatible lender
- Get a checking account
- Keep your debt-to-income ratio low
Step four is so important it’s worth repeating. Do your research and only approach lenders with compatible eligibility requirements. SuperMoney’s personal loan comparison tools make this easy because it allows you to filter lenders by the minimum credit score they require. Trying your luck with lenders that are likely to reject your loan application will only make a bad situation worse.
Steps To Qualify For A Personal Loan
1. Secured or Unsecured?
Whether you apply to a bank, a credit union or a finance company, the first question you need to ask yourself is whether you want a secured or unsecured loan.
- Secured loans are backed by valuable assets that are pledged as collateral. Mortgages and car loans are among the most common types of secured loans. Pawn shops and auto title lenders also provide secured loans. Secured loans are easier to qualify for because they are less risky for lenders. After all, the lender can keep the security if the borrower doesn’t pay the loan. If your credit is not great and you have property to leverage, secured loans can help you qualify for better interest rates.
- Unsecured loans carry less risk for borrowers because they do not require collateral. They are often called signature loans because the borrower’s signature on the loan contract is the only guarantee the borrower will repay the loan. The lender extends credit based solely on the borrower’s credit history. If your credit is not good (over 700), you will struggle to qualify for loans with competitive interest rates.
2. Check Your Credit Score
Your credit score is a measure of your reliability as a borrower. The higher your credit score, the more likely you are to qualify for loans. Some websites, such as Credit Sesame, will let you check your credit score for free. Although free credit scores are a great place to start, you should also invest in getting your FICO score with all three national credit bureaus: Equifax, Experian, and TransUnion. FICO scores are the credit scores most lenders use to determine eligibility.
3. Improve Your Credit Score
If your credit score is under 760, try to improve it before applying for a loan. However, once you have excellent credit, don’t obsess about improving it further. Increasing your score by a few points will not have much of an impact on your loan terms. The law of diminishing returns applies to credit scores and personal loans.
How can you improve your credit score?
- Obtain copies of your credit report from all three major credit reporting agencies: TransUnion, Equifax, and Experian.
- Correct any errors including outdated entries and disputes. Don’t overlook mistakes like wrong addresses or misspellings of your name. Such “small” errors can mean the difference between approval and denial.
- Pay off overdue bills or negotiate repayment agreements with creditors. Clean up checking account overdrafts and bounced checks. If there are mitigating factors such as job loss or serious medical issues that caused you to fall behind on your bills, you have the right to include a 100-word statement along with your credit report.
4. Match Your Credit Score To A Compatible Lender
Once you know what your credit score is, avoid lenders that are unlikely to approve you. SuperMoney makes this easy. Just select your credit score and SuperMoney’s search engine will filter out the lenders with credit requirements you currently don’t meet. Every time you apply for a loan, lenders will run your credit report, which will lower your credit score a little (around 5 to 10 points). Two or three credit pulls are no big deal, but it’s smart to keep unnecessary credit inquiries to a minimum.
Less than 600: Poor Credit
If your credit is below 600 your options are limited. Avoid borrowing money until you rebuild your credit. Payday loans and pawn shops are probably the only lenders that will consider you. If you really must borrow money, use lenders that report your payments to major credit bureaus, such as LendUp. You may only qualify for its highest interest rates, which are comparable to payday loans, but at least you will be giving your credit score a chance.
Less than 700: Fair Credit
Less than 760: Good Credit
You probably won’t qualify for super-prime lenders, such as SoFi or Lightstream but most lenders will approve your loan application. Expect good (but not awesome) terms and rates. Try prime lenders, such as LendingClub and Avant.
Over 760: Excellent Credit
Congratulations. If your income matches your credit score, lenders will fight over your business. Start with super-prime lenders, such as SoFi or Lightstream. Don’t feel bad if you are denied credit. Your credit score is not the only factor lenders consider. Your income and outstanding debt also play an important role.
5. Get A Checking Account
Most personal loan providers require borrowers to have a checking account. If you don’t have a checking account, you are not alone. According to a 2013 study by the FDIC, 9 million Americans (8 percent of households) do not have a bank account. If you don’t have a checking account because you’ve been turned down, you probably have a negative history with a reporting agency called ChexSystems. Maybe you bounced some checks or your account was closed due to overdrafts. Negative items remain in ChexSystems for 3 to 5 years unless you clear them up. Pay off overdrafts or bounced checks, and report the repayment to ChexSystems.
In the meantime, seek out banks and credit unions that don’t use ChexSystems to verify new accounts. Some banks, such as Wells Fargo, TD Ameritrade, Axiom Bank, Woodforest National Bank, United Bank, and Green Dot Bank, offer second chance checking accounts that don’t use ChexSystems. You may initially face mandatory fees or limitations, such as not being able to obtain a debit card. But those restrictions should be removed within 6 to 12 months if you maintain the account responsibly.
6. Keep Your Debt-To-Income Ratio Low
Research shows that borrowers with a high debt-to-income ratio are more likely to default on their payments. Mortgage lenders often use a 43 percent debt-to-income ratio as the highest ratio a borrower can have and still qualify for a mortgage. A debt-to-income ratio lower than 36 percent is preferable. The threshold used by personal loan providers varies but the lower you keep your debt-to-income ratio the better your chances.
How do you calculate your debt-to-income ratio?
Your debt-to-income ratio is determined by dividing your monthly debt payments by your gross monthly income and multiplying by 100. Let’s say you have a $1,300 mortgage, a $300 car payment, and $400 in credit card debt. Your monthly debt payments would be $2,000. If your monthly income is $6,000, your debt-to-income ratio would be 33 percent ((2,000 / 6,000) x 100).
There are three ways to lower your debt-to-income ratio.
1. Pay off your debt as soon as possible. Following our previous example. Imagine your income remains the same and your lower your monthly debt payments to $1,000 a month. Your debt-to-income ratio would be 17 percent.
2. Increase your income. Let’s say you increase your income to $8k and everything else remains at $2k, your debt-to-income ratio would be 25 percent.
3.Pay off your debt and increase your income. Find a better job or a second one, and repay your debt as fast as you can. If you raised your income to 8k and dropped your debt payments to $1k a month, your debt-to-income ratio would be 12.5 percent.
The key to qualifying for a personal loan is to act decisively based on reliable information.
- You need to know where you stand in the eyes of lenders. To do this you must check your credit score. You can do it for free here.
- If your credit score is low, focus on rebuilding your credit history before borrowing money. If waiting is not an option, get ready to pay high interest. Applying for a secured personal loan may help.
- Get a bank account. If your credit is bad, apply for a second chance account. Improve your credit history by paying your bills regularly and on time.
- Keep an eye on your debt-to-income ratio. The lower the better. Aim to keep it below 25 percent.
- Don’t set yourself up for failure. Only apply for loans with lenders that have credit requirements that match your credit history.
SuperMoney provides valuable (but free) tools that allow you to check your credit score, calculate your debt-to-income ratio, and filter lenders by their credit requirements and interest rates. Happy hunting.
Andrew is the managing editor for SuperMoney and a certified personal finance counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.