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I Have Great Credit But Didn’t Get Approved for a Loan
Consumers who’ve built a great credit profile should be deservedly proud of the work they’ve done to get there. Imagine then the surprise you’d feel if a lender turned down your application for a personal loan. Sadly, a high credit score is sometimes not enough to gain loan approval, often because of one or more of these factors:
- High debt levels
- Insufficient income
- Unreliable income
Lenders look at these factors when evaluating the risk that you’ll make late payments or even default on your loan.
Typically, personal loans are unsecured, meaning that your signature is all that guarantees you’ll service the debt properly. Unlike a mortgage or car loan, personal loans are not backed by collateral that secures the loan against default. Therefore, these loans require tighter scrutiny that may result in higher interest rates, smaller approved amounts, and even outright rejection.
Let’s explore these three factors in more detail and see what steps you can take to mitigate them.
High Debt Levels
Lenders look at your capacity to take on additional debt using various metrics, such as debt-to-income (DTI) ratio. This ratio compares your monthly debt payments to your monthly gross income (i.e., total income before taxes and other deductions).
As your DTI ratio increases, your ability to assume additional debt falls. The reason is simple: When you must spend a large percentage of your monthly income on debt service, you are more vulnerable to financial distress should surprises occur. Lenders worry that a sudden financial shock will force you to miss loan payments, and when your DTI is high, you have less wiggle room to respond.
Different types of lenders will have varying requirements for an applicant’s DTI. For example, mortgage lenders start to fret when your DTI rises above 36% and may reject outright borrowers with DTIs above 43%. Personal loan providers usually require lower DTIs since they are not secured by collateral.
If your loan is rejected because of your DTI ratio, you can address the problem by paying down some of your existing debt. However, that can be a challnge since your desire for additional borrowing despite a high DTI implies you have little money available to pay down debt. In that case, you’ll need to find ways to cut your overall monthly expenses and/or increase monthly gross income.
Even with a good credit score, the amount you want to borrow might be too high given the income you earn each month. Sometimes, you might be able to settle for a smaller loan. Your ability to do so hinges on your financial circumstances. For example, if you’d like a loan to finance a particular project, event, or purchase, perhaps you can modify your plans and make do with a smaller loan.
Make sure your loan application includes all sources of income. Perhaps you have a secondary gig that provides extra income, or an annuity that delivers fixed payments each month. You may have skills that you can monetize, such as writing, home repairs, driving, or landscaping.
Taking on extra work means additional income, making you a more attractive loan candidate. It can also reduce the amount you need to borrow. Higher income plus a smaller loan request will improve a lender’s assessment of your ability to repay.
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Some lenders may treat your income as risky if you are self-employed or earn irregular income. This is one reason why many lenders want to see at least two years of tax returns. For better or worse, self- employed individuals and small business owners are often at a disadvantage because they aren’t backed by the resources of a large company.
Even when you have a FICO score above 700, lenders may look askance at your income stream. Self-employed people face some challenges that can heighten lenders’ perceptions of risk, including:
- Stress: When the entire enterprise rests on your shoulders, business problems are personally stressful and can lead to burnout. This compromises your ability to devote the energy needed to keep the business from disintegrating.
- Competition: Depending on the type of business, you may face more than local competition. For example, if you are a landscaper, your competitors probably operates in the same area. Contrast that to, say, article writers, who must face national and international competitors because the internet makes location moot. Competition forces down prices, and larger companies with deeper pockets can sink your business.
- Expectations: Another side effect of competition is that clients demand top quality service at low prices with quick turnaround. This leaves little room for mistakes, one of which can alienate a client forever. Naturally, you want to keep all your clients happy, but when you’re a one-person company, your ability to do so may be stretched beyond reasonable limits.
Other risk factors include seasonality, obsolescence, and innovation. It may not seem fair, but lenders are tougher on the self-employed than they are on wage earners. Combat this challenge with comprehensive records of your employment history and income, backed by your tax documents and bank statements.
Eric Bank is a business and personal finance writer who has been featured in Credible, Wisebread, CardRates, Zacks and many other outlets. He holds an M.B.A. from New York University and an M.S. in Finance from DePaul University.