Personal loans are on the rise. Americans have over $1.6 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 to get a personal loan application approved and help you avoid common mistakes that could damage your credit in the process.
How To Qualify For A Personal Loan?
- Determine what type of loan is best for you.
- 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. Different personal loans come with different rates, fees, and requirements, so check out the best personal loans to ensure that you choose the best option for you. SuperMoney’s personal loan comparison tool makes this easy because it allows you to filter lenders by the minimum credit score they require.
If you have poor to mediocre credit, trying your luck with lenders that are likely to reject your loan application will only make a bad situation worse. The reason is that each time you apply for a personal loan, it counts as a hard inquiry on your credit report. Hard inquiries may impact your credit score and make securing a loan more difficult. On average, a hard inquiry will result in a credit score drop of 5-10 points, usually less if your credit history is strong. Though this is a small decrease in a credit range of 300-850, several dings to a less than stellar score could be significant. (Note that hard credit inquiries do not impact your score after one year and are no longer visible after two.)
The main takeaway is, if your credit is only so-so, it is better to wait and raise your credit score first before risking more damage, so be sure that you are in good enough financial shape before applying for personal loans. Loans are still available for individuals with bad credit, which we will address below.
Steps To Qualify For A Personal Loan
1. Determine the type of loan that’s best for you
Secured v. Unsecured Personal Loans
Whether you apply to a bank, credit union, finance company, or online lenders, there are a couple of questions to ask yourself in order to determine what type of loan to apply for. First, do you want a secured or unsecured personal 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. 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 a property to leverage, secured loans can help you qualify for better interest rates. Personal loan lenders who offer them will give you the option of taking a savings-secured loan, which uses a savings account–either a money market account or certificate of deposit (CD)–as collateral rather than physical assets. Note: Pawn shops also provide secured loans by lending around 25%-60% of the resale value of personal property you leave with them until the loan is repaid. Auto title lenders and payday loans also advertise as “secured loans,” though these are not the same as those offered by a bank or credit union and should be avoided. Their interest rates are exorbitantly expensive–often over 400%– and can be virtually impossible to repay. In fact, they are banned in many states. It is better to take on a bad credit loan with a high interest rate than to get tangled up with payday lenders.
- 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 interest rate is usually higher on unsecured loans since there is nothing for the bank to repossess if you fail to pay it. 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 unsecured personal loans with competitive interest rates.
Variable vs. Fixed-Rate Interest Loans
The other thing to consider is whether you want a variable or fixed-rate loan. Most personal loans are fixed-rate loans, although there are lenders who offer variable-rate loans. Variable-rate loans, sometimes known as adjustable or floating interest rate loans, can change over the life of the loan. Variable-rate loans usually start at a lower interest rate but carry the risk of increasing with the national prime rate, which adjusts with inflation. Fixed-rate loans, however, remain the same over the life of the loan, regardless of economic fluctuations and financial inflation. They provide the certainty of knowing what your payment will be until the loan is paid off.
Types of Lenders
The three main types of reputable lenders are banks, credit unions, and online lenders (though it’s a good idea to proceed cautiously with the last). Knowing what type of loan you want to get can help you narrow down what type of lenders to approach.
- Banks may offer the most competitive interest rates and can usually get funds into your bank account quickly (within 2-3 days). However, bank loans may also come with origination fees attached, which can increase the overall amount you pay back. They also tend to have higher credit standards, and you may find you need good to excellent credit to get approved for a personal loan.
- Credit union lending standards may be a bit more flexible and make it more likely you’ll get a loan, especially if you have a longstanding relationship with them. Credit unions frequently offer lower interest rates and fees and may be able to work with individuals with poor to middling credit, more so than another type of lender. Additionally, they sometimes offer discounted interested rates to members. The catch is you must qualify to be a member.
- Online lenders are a great option for borrowers looking for competitive rates, convenience, and speed. Online loans usually have fixed annual percentage rates. If you know where to look, you can get loans with low rates, no fees, and soft credit checks
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 a loan, because you are considered more likely to repay the loan. You can obtain copies of your credit report from AnnualCreditReport.com. Federal law entitles you to a copy of your report from each of the three major credit reporting agencies–TransUnion, Equifax, and Experian–every 12 months. Other websites, such as Credit Sesame, will also let you check your credit score for free. Although free credit scores are a great place to start, you should invest in getting your FICO score with all three national credit bureaus if necessary. 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. The higher your credit score, the more likely you will get a lower interest rate and qualify for a higher loan amount. 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 raise your credit score?
- Review your credit report carefully. After you’ve obtained copies of your credit report, correct any errors, including outdated entries and disputes. You may find credit cards that were taken out by someone else with a similar name or balances that you have long since paid off. Don’t overlook mistakes like wrong addresses or misspellings of your name, which may impact your score. Be sure to report each error to the company which issued the account or the credit reporting company. Such “small” errors can mean the difference between approval and denial.
- Pay down your debt. 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.
- Consolidate payments. Debt consolidation is a very common reason to get a personal loan in the first place, as it can decrease the hassle of multiple monthly payments to one manageable payment with a potentially lower interest rate. Another option would be to take advantage of a 0% interest credit card balance transfer, presuming you can pay off the debt within the promotional period.
Once you’ve put in the effort to boost your credit score, commit to using credit responsibly. Don’t miss payments or apply for several credit cards at once, and keep debt at a manageable level. And remember, although it is possible to rebuild your credit score by yourself, there are credit repair companies and credit counseling agencies that can help if you need it.
4. Match Your Credit Score To A Compatible Lender
Once you’ve done a credit check and 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 personal loan lenders with credit requirements you currently don’t meet. Every time you apply for a loan, lenders will run your credit check, which will lower your credit score a little. As stated earlier, 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. If possible, avoid borrowing money until you rebuild your credit. Payday loans and pawn shops are options, but the interest rates are very high. If you really must borrow money, use lenders that report your payments to major credit bureaus. 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 Upgrade, 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 Upgrade. 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 to get a loan. 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 a bank or credit union that doesn’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 (DTI) 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 DTI ratio lower than 36 percent is preferable. The threshold used by personal loan providers varies, but the lower you keep your DTI ratio, the better your chances to get approved.
How do you calculate your debt-to-income ratio?
Your DTI 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 DTI 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 you lower your monthly debt payments to $1,000 a month. Your DTI 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 DTI 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 DTI ratio would be 12.5 percent.
How to Get a Personal Loan with Bad Credit
While it’s always best to raise your credit first and ensure you are in fit financial health before applying to get a personal loan, there may be situations in life in which you find yourself desperate. In this lamentable case, know that it is still possible to get approved for a loan even if you have bad credit. Obtaining a personal loan when you don’t have good credit generally comes with suboptimal terms and conditions; such loans usually have higher interest rates and lower maximum amounts. Still, they may get you more favorable interest rates than credit cards can offer.
Enlist a cosigner
If you don’t meet the financial qualification requirements to get a loan on your own, you may want to consider one approach enlisting a cosigner. Normally, this would be a friend or family member with strong credit who can boost your chances of getting approved for a personal loan. However, this is not a decision to take lightly as the individual will be legally on the hook to pay the loan should you fail to do so. Make sure you carefully consider what you are asking, and take the responsibility to make your monthly payment on time very seriously.
If you can’t find a cosigner or are uncomfortable asking someone, you may be able to get a loan with an online lender such as OppLoans or Earnin without resorting to exorbitant payday-loan-level terms and conditions. Rather than looking at your numerical credit score, OppLoans considers your employment, income details, and personal financial history to determine approval.
Consider a Home Equity Loan
Even with imperfect credit, it’s possible that you may qualify for a home equity loan. A home equity loan is another type of secured loan that uses the equity you have accrued in your home as security. Although this type of loan is more forgiving of your personal credit, you’ll still need a score of at least 620 or higher to get approved.
As with any major financial decisions, it is important to do your homework and exercise caution when seeking a personal loan. A few things to remember proceed:
- Gather your personal information, credit reports, and history, and ensure that the information they contain is correct.
- When you are ready to apply, be prepared to demonstrate your ability to repay the loan. Know what you can afford in monthly loan payments.
- Beware of predatory lender schemes.
- Make sure to always read the fine print in loan offers, terms, and conditions.
- Look out for origination fees.
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. Build up 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 Content Director for SuperMoney, a Certified Financial Planner®, 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.