Have you recently applied for a loan and had your application declined? It can be very frustrating, especially when access to credit is growing in the U.S. In 2016, over 12 million people gained access to credit products including credit cards, personal loans, and auto loans, according to Transunion’s Q4 2016 Industry Insights Report.
Furthermore, Transunion reported that the number of people with personal loans steadily grew throughout 2016 to the highest level since Q3 of 2009 and loan balances surpassed $100 billion for the first time in history. What are the main reasons you might get declined for a loan, despite this growth? Here’s what you need to know.
Low credit score
Your credit score is one of the primary factors that lending companies look at when considering whether or not they’re going to approve your loan application. According to Equifax, this score is calculated based on your payment history, public records, length of credit history, new accounts, account inquiries and accounts in use. This information helps lenders to determine the level of risk you present to them.
Minimum credit score requirements will vary from one lender to the next. For example, Avant, a company that provides access to personal loans, states that its typical customer has a credit score between 600 to 700.
Lending Point is another lender that specializes in personal loans, and its average borrower has a credit score between 600 to 680.
To prevent being denied a loan, check your credit score before applying. After you do that, research the credit score qualifications of various lenders. Make a shortlist of the lenders that offer loans to consumers in your credit range. If your score is not high enough to qualify for any of the loans you want, audit your credit report to find out why. You may need to correct errors, settle past debts or make timely payments on another debt to help build a positive credit history.
High debt-to-income (DTI) ratio
The amount of debt you currently have will also play a role in getting approved for a loan. According to the Consumer Financial Protection Bureau (CFPB), your debt should not be more than 43% of your income. Once you pass that ratio, lenders are likely to deny your loan application. A good DTI is between 30% and 36%.
To find out your DTI ratio, calculate your monthly gross income. Then, add up the total amount of monthly payments you make towards your debts and divide the total by your monthly gross income. For example, if you make $4,000 per month and you pay $1,500 towards other debts, your ratio would be $1,500 divided by $4,000, which is 37.5%. This would be a little on the high end, but still under the maximum amount.
So, find out where your current debt-to-income ratio stands. Don’t forget that it needs to be below 43%, including your new loan payments. If you have too much debt, you’ll need to take actions such as paying it down, lowering your monthly debt payments through refinancing or increasing your gross monthly income.
High credit utilization ratio
Credit utilization, while a primary factor in your credit score, may also be looked at independently. It is the amount of credit that you have used in comparison to how much is available to you.
For example, if you have a credit card with a $7,500 limit and you have a balance of $7,000, 93% of your available credit would be utilized. Some companies look at your overall debt compared to total credit available, while others look at your specific credit cards or lines of credit. With this in mind, it’ s good to manage both your total credit utilization ratio and the ratio on each individual account.
The higher the credit utilization ratio, the worse it is in the eyes of lenders. This is because they want to see that you can use debt responsibly and manage it in a controlled manner. The recommended credit utilization ratio, according to Experian, is 30% or less. This means that a $7,500 credit card should maintain a balance of $2,250 or below.
If your credit utilization ratio is too high, the easiest thing you can do is try to get an increase in your credit limits. If you are still above the recommended ratio or are unable to get an increase approved, you will need to focus on paying down some debt before applying for a loan.
Lenders also want to know that you have a stable job that will allow you to pay for the loan. For example, SoFi requires you to have a job, a job offer for a job which you will start within 90 days or sufficient income from other sources.
You will often have to prove your employment by verifying your income, as is the case with Check Into Cash, a payday lender. It requires pay stubs and a bank account that has been active for at least 90 days. Be prepared to prove how you earn money and that you do so on a regular basis.
It’s also important to ensure you fill out the loan application carefully. Small errors on the form can cause denial, and you don’t want to miss the opportunity because of an avoidable mistake. Be sure to check all of the fields carefully to ensure you enter the accurate information.
Not a U.S. citizen or permanent resident alien
Another technicality that can disqualify you from getting approved for a loan is your citizenship or residency status. Most lenders require that you are a U.S. citizen with a social security number or a permanent resident alien.
Lenders don’t serve your state
Last but not least, not all lenders are nationwide. Be sure to check which states a lender serves and verify that they provide loans in your state before you apply.
Be prepared and get approved
When you decide you need a loan, save yourself the time and trouble of getting declined by preparing ahead of time. Be sure to check your credit score, DTI ratio and credit utilization ratio. If they aren’t up to par, take steps to get them into shape.
Beyond that, it’s a matter of managing the fine details such as proving your employment, avoiding mistakes on the application, proving residency or citizenship and finding a lender that serves your state. Remember, most lenders will have their minimum qualifications on their websites, so do a little research before applying to find the right company for you.
Do you want to compare loan companies in one place? Head on over to our personal loan review page where you can see a wide range of lenders and real user ratings about their services.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.