Credit plays a big role, but it’s not the only deciding factor.
You want to do your best when applying for a mortgage, car loan, or personal loan, but that can be hard to do when you’re not sure what your lender is looking for. You may know that they usually look at your credit score, but that’s not the only factor that banks and other financial institutions consider when deciding to work with you. Here are seven you should know.
1. Your credit
Almost all lenders look at your credit score and report because it gives them insight into how you are handling borrowed money. A bad credit history indicates an increased risk of default. This scares off many lenders because they may not get back what they lent you.
Scores range from 300 to 850 with the two most popular credit scoring models:
The higher your score, the better. Lenders generally don’t disclose minimum credit scores, in part because they consider your score in conjunction with the factors below. But if you want the best chance of success, aim for a score in the 700 or 800 range.
2. Your income and work history
Lenders want to know that you will be able to repay what you borrow and as such they need to ensure that you have sufficient and consistent income. Income requirements vary depending on how much you borrow, but generally if you borrow more money, lenders will need to see a higher income to be sure you can keep up with the payments.
You will also need to be able to demonstrate stable employment. Those who only work part of the year or self-employed people just starting their careers may have a harder time getting a loan than those who work full-year for an established business.
3. Your debt to income ratio
The debt-to-income ratio is closely related to your income. This looks at your monthly debts as a percentage of your monthly income. Lenders like to see a low debt-to-income ratio, and if your ratio is above 43% – if your debt payments are no more than 43% of your income – most mortgage lenders won’t accept you.
You may still be able to get a loan with a debt-to-equity ratio above this amount if your income is reasonably high and your credit is good, but some lenders will turn you down rather than take the risk. Work to pay off your existing debt, if you have any, and reduce your debt-to-equity ratio to less than 43% before applying for a mortgage.
4. Value of your guarantee
Collateral is something you agree to give the bank if you are unable to meet your loan repayments. Loans that involve collateral are called secured loans while those without collateral are considered unsecured loans. Secured loans usually have lower interest rates than unsecured loans because the bank has a way to get their money back if you don’t pay.
The value of your collateral will also partly determine how much you can borrow. For example, when you buy a house, you cannot borrow more than the current value of the house. This is because the bank needs the assurance that they will be able to get all of their money back if you are unable to keep up with your payments.
5. Down payment amount
Some loans require a down payment and the amount of your down payment determines the amount of money you need to borrow. If, for example, you’re buying a car, paying more up front means you won’t need to borrow as much from the bank. In some cases, you can get a loan with no down payment or a small down payment, but be aware that you will pay more interest over the term of the loan if you choose this route.
Lenders like to see that you have money in a savings or money market account, or assets that you can easily turn into cash in addition to the money you use for your down payment. This reassures them that even if you suffer a temporary setback, such as losing a job, you will still be able to meet your payments until you get back on your feet. If you don’t have a lot of cash on hand, you may have to pay a higher interest rate.
7. Duration of the loan
Your financial situation may not change much over the course of a year or two, but over the course of 10 years or more, your situation may change a lot. Sometimes these changes are for the better, but if they are for the worse, they could affect your ability to repay your loan. Lenders will generally feel more comfortable lending you money for a shorter period, as you are more likely to be able to repay the loan in the near future.
A shorter loan term will also save you more money because you’ll pay interest for fewer years. But you’ll have a higher monthly payment, so you need to take that into account when deciding what loan term is right for you.
Understanding the factors that lenders consider when evaluating loan applications can help increase your chances of success. If you think any of the above factors may be hurting your chances of approval, take steps to improve them before applying.
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