If you want to buy a large item such as a vehicle or a home, chances are you will apply for a loan. Be prepared to lay your current assets and liabilities open for scrutiny. When considering your application, lenders look at a number of aspects to your financial situation to determine if you are a good candidate. Having a better idea of what lenders are looking for can help you increase your chance of approval.
Here are five factors that many lenders consider before loaning money to applicants.
Income And Expenses
Lenders may compare your income level to the number of expenses you have. The higher your income, the more attractive you are to many lenders because they see you better able to meet all of your monthly financial obligations without defaulting on payments.
Often called a debt-to-income-ratio (DTI), this calculation must be 43 percent or lower in order to get a loan from a highly regarded lender. Basically, this figure measures the total amount of your monthly debts compared to your gross monthly income. To keep your DTI low and help improve the score, which in turn can increase your chances of being approved for a loan, start paying off large debts before applying for loans. In addition, do not ask for new lines of credit before turning in your application.
Many lenders look at more than your three-digit credit score. They study your entire credit report to get a better idea of how you manage your financial resources and meet obligations. They also look for potential warning signs:
- Outstanding debts
- Unpaid accounts in collections
- Numerous new applications for credit
Flaws will not necessarily cause your application to be rejected, but they may make your interest rates higher. There are services offering free credit reports. To see how your score compares with others around the country, study a reliable credit health research report. This will help you better understand credit scores lenders are seeing from other applicants.
Lenders will carefully consider the value of the vehicle or house you want to buy because it will be collateral for the loan. This means they will look at the big-ticket item for its worth as security or a guarantee for their financial protection should you default on your payments. Loans with collateral are called secured loans.
The lower the value of the item you want to buy as compared to the loan you seek, a figure called the loan-to-value ratio, the higher your interest rate is likely to be. Lenders want to be sure to recoup as much of the loan as possible, so the higher rates compensate lenders for taking the risk.
In addition to collateral, lenders may want to know if you have liquid assets as well. They are interested in whether you have quick access to cash to meet your monthly obligations should there be an interruption in your regular monthly income for some reason. Such financial assets come in several forms.
These assets may help you get a lower interest rate because you are seen as a lower risk than someone without them.
Length Of Loan
Considering the loan term is important because it can affect the way lenders look at you. Shorter loan terms are generally more expensive, but if you can afford the payments, you may want to apply for one. Many lenders view applicants for shorter loan terms as having secure finances and therefore may look upon them favorably. While payments for these loans are higher than for loans with longer terms, your interest rates may well be lower.
On the other hand, if you do not have the resources for expensive loans, long-term loans offer lower regular payments, though you will pay more in interest for the life of the loan. However, you can budget for regular monthly payments, which help you build credit and prove you are a good financial risk.
If you want a loan for a large item, your current income could satisfy lenders that you are a safe risk and earn you a lower interest rate. However, some lenders want to see your earnings over a period of time such as the past two years. They check your employment history to gauge whether your income is stable. If you have an irregular job history or were unemployed close to the time of your loan application, lenders may grow wary. These factors do not mean you will automatically be rejected outright, but you might have to pay higher interest rates.
Proactive Steps To Help Your Chances
There are specific things you can do before applying for a loan to improve your chances of approval.
- Keep credit card balances low
- Pay all bills on time every month
- If your credit is poor, build it up through a secured credit card or a credit-builder loan
You can also get credit for the bills you are paying. Services such as Rental Kharma and RentTrack put monthly payments you make on your credit report to help establish a positive credit history. Experian Boost allows you to have your utility and mobile phone bills reported on that agency’s credit report.
Lenders look at multiple factors when considering your application for a loan. Even if you have a less-than-perfect credit history or employment record, take heart. There are ways to boost your credit and make your financial situation look more secure to lenders. With a bit of planning and positive action, you have a good chance of being approved for the loan you want at interest rates you can afford.