If you’re in the market for a loan, your credit score is one of the biggest factors that lenders consider, but it’s just the start.
Lenders like to see an applicant’s full financial profile when deciding whether to approve a loan and when setting the interest rate. So when you fill out a loan application, be prepared to share more than just your credit score.
What lenders look at in your application
A credit score is a three-digit number — calculated from the data in your credit reports — that is designed to predict how likely you are to repay borrowed money.
But a score doesn’t tell lenders everything, so many also look at your credit reports from the three major credit bureaus. Credit reports contain your credit history, which is a record of how you’ve managed debt payments. Lenders may look for:
- Delinquent accounts, meaning those paid more than 30 days late.
- Unpaid collections accounts.
- A past bankruptcy.
- Number of recent applications for credit.
- Outstanding debts.
While one or more blemishes might not be deal breakers, having them on credit reports can affect your interest rate. Not sure what your credit profile looks like? You’re entitled to a free copy of your credit reports from the three major credit bureaus every 12 months. Access them by using AnnualCreditReport.com, then review the information to fix any mistakes and to understand how lenders will see you.
Income and expenses
A lender is less likely to view you as a risk if you have a good income because you’re more likely to be able to pay all your obligations every month. On the flip side, a high income may not help you get a better rate if your fixed expenses, such as your rent or mortgage payment, are especially high.
For example, when applying for a mortgage from the Federal Housing Administration, your total debt-to-income ratio must be 43% or lower to qualify for a loan with a reputable lender. Lenders allow some flexibility depending on your credit score. Someone with a lower credit score needs to meet the 43% limit, but if your score is on the higher side, FHA mortgage lenders may allow a ratio as high as 50%.
If you apply for an unsecured personal loan, which is based on your credit, a high income or low amount of existing debt can be even more important. If your score is low because you are new to credit or rebuilding your score, some lenders will consider the high income and overall debt load.
The lower your loan amount, the less risk to the bank. If you have a large down payment, the lender is more likely to be generous with the interest rate. If your credit score is borderline and you don’t qualify for a loan, a sizable down payment might help you get approved.
Keep in mind that getting a slightly lower interest rate may not be worth cleaning out your bank account. It’s important to keep enough cash in savings in case of an emergency.
The length of the loan is important. In general, lenders assume that a shorter loan means the borrower’s ability to pay is less likely to change over the life of the loan. Keep this in mind when you apply for a loan. If you can afford a loan with a shorter term, the monthly payment may be higher, but you’ll pay less in interest over the life of the loan, and you’ll be out of debt sooner.
If you’re applying for an auto loan or mortgage, the lender will look closely at the value of the vehicle or house because it will act as collateral for the loan. For example, say you plan to buy a $15,000 car. Add in $5,000 in after-market warranty and maintenance contracts, gap insurance and sales tax, and you’re looking at a loan for $20,000. The loan-to-value ratio is 133% ($20,000 / $15,000 = 1.33). In this case, if the vehicle is totaled or you default on the loan and the lender tries to resell the car, it most likely won’t recoup the full $20,000. Instead, the lender will likely want a higher interest rate to compensate for the risk.
A loan with collateral is called a secured loan, and it typically comes with a lower interest rate than an unsecured loan (one with no collateral). That’s because you agree the lender can seize the collateral if you fail to make payments.
We recommend caution when considering using your house or car as collateral when applying for a secured personal loan. If you don’t repay the loan, you can lose your home or transportation.
You’re expected to use your income to repay the loan, but some lenders may want to know whether you have assets that can be converted into cash quickly, such as a savings or money market account, stocks or government bonds.
If you do, you have ways to cover payments in case you lose your job or have other financial setbacks. If you have liquid assets to cover the cost of the loan, the lender may view you as less risky and may offer a lower rate.
If you’re applying for a mortgage, your current income may be enough to qualify for a good rate. But the lender may choose to review your income in the past year or two to measure income stability. If you have a spotty job history or were unemployed recently, you might not be denied, but the issuer may charge a higher interest rate.
What you can do
You can improve your chances of getting a loan, and with favorable terms, by demonstrating good credit behaviors like paying all bills on time and keeping your credit card balances low.
Be aware of the factors listed above, and do what you can to make your overall financial picture look good to lenders.