3 Reasons Why Your Personal Loan Was Declined
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Taking out a personal loan can be a great way to refinance high-interest debt, pay for home repairs and other expenses. It can be a better option than using your typical credit card because personal loans could offer lower average interest rates depending on your credit.
Not having a good credit score, along with other factors, can lead to high offered interest rates — if you’re approved at all. But understanding why you were declined and what you need to fix can improve your chances of being approved in the future.
Why you may have been declined for a personal loan
Besides having a low credit score, other reasons for being declined for a personal loan include having a high debt-to-income (DTI) ratio and requesting to borrow too much money. If your loan is denied by one lender, however, you can always try applying with another. Each lender sets their own lending requirements.
If your request for a personal loan keeps getting rejected, take a moment to understand how to get your loan approved. Plus, by taking time to learn how to improve your credit score and DTI ratio, you could secure a lower interest rate.
If you’re unsure why you were declined for a personal loan, reach out to the lender. Under the Equal Credit Opportunity Act, lenders must explain to you why your loan was rejected or give you instructions on where to look to find the reason.
Problem: Your credit score is too low
When a lender views your personal loan application, they commonly consider your FICO credit score, among other factors like your income. Your credit score tells lenders how good you may be at managing money. Factors like your payment history and amount owed are heavily weighed in your credit score.
Since personal loans are usually unsecured debt — debt that doesn’t have collateral attached to it — lenders usually have stricter lending requirements.
Lenders commonly publish their minimum credit requirements. If you fall below a lender’s minimum, you’ll likely struggle to qualify for a loan from them. Even if you’re approved for a loan with a low credit score, lenders will charge you a higher rate to compensate for the risk of you not being able to repay the loan.
Solution: Build your credit score before you apply
To avoid being denied for a personal loan due to having a low credit score, the best thing you can do is build or repair your credit score before applying. Here is a look at how your credit habits and debt is factored into your credit score:
Here are some actions you can take now to improve your credit score:
- Get a copy of your credit report and dispute any errors.
- Set up automatic bill payments to avoid missed or late payments.
- Pay down credit card debt to decrease your credit utilization.
- Seek nonprofit credit counseling for help with debt, whether it’s current or past due.
Problem: Your debt-to-income ratio is too high
Another problem you may have is a DTI ratio that’s too high. This ratio compares your monthly debt total with your monthly gross income. For example, if your monthly debt payments are $3,000 and you divide that by your monthly income of $5,000, then your DTI ratio would be 60%. A high ratio such as this could signal to lenders that you might struggle to afford debt repayment.
For that reason, it’s best to aim for a DTI ratio of 35% or less, which is considered good. That way you’d increase your chances of loan approval.
Solution: Look for ways to increase your income and pay down debt
To improve your DTI ratio, you have two options: increase your income or pay down your debt. If you do both simultaneously, you’ll improve it faster. However, increasing your income isn’t an easy task, but there are other strategies you can use to get out of debt.
For example, you could try the debt snowball repayment method. This method involves paying off your lowest amount of debt first before tackling the next-smallest debt balance. Alternatively, you could use the debt avalanche method, which involves paying off the debt with the highest interest rate first before paying off the next debt with the highest interest. Although the avalanche method is ideal if you want to minimize interest costs in debt repayment, a debt snowball can keep you motivated over time by offering short, quick wins.
Using the example from the previous section, imagine if you increase your monthly income from $5,000 to $6,500, while reducing your monthly debt payments to $2,000. Your DTI ratio would be a little over 30%, which would increase your chances of being approved for a loan.
Problem: You tried to borrow too much
If you try to borrow more than you can afford to pay back, a lender may deny your request for a personal loan. This is because the amount the lender approves you for is based on your income and other debt obligations. After reviewing your finances, the lender may decide you don’t qualify to borrow a certain amount.
For example, let’s say you try to take out a personal loan for $100,000, knowing that you don’t earn enough income to afford the monthly loan repayment. Since you’re requesting an unrealistic amount, the lender will most certainly deny you.
Solution: Request a more realistic loan amount
The solution to this problem is to request a more realistic loan amount. To do this, take a look at your budget and use a personal loan calculator to get a better idea of how much money you can afford to spend each month repaying your personal loan.
By doing this, you’ll increase your chances of getting approved. In addition, you won’t risk taking out more debt than you can handle.
How to get a personal loan with bad credit
Although building your credit and improving your DTI ratio will help, they can take a lot of time. If you need to pay for an emergency medical expense and want to avoid taking out a payday loan, or you need money from a personal loan now and can’t wait to build your credit score to apply again, there are other options you can take to get a loan when you have bad or no credit.
Check with your local credit union
One of the first options you should consider is checking to see if your local credit union will offer you a personal loan. Credit unions are not-for-profit organizations that can offer more competitive personal loans than national banks. Your employer might have a credit union for its employees, so check there first. Some credit unions will allow you to join if you’re the family member of a person who is a member of a specific group or organization.
If you don’t have access to one through your employer or a family member, do some research on the credit unions for personal loans in your area. Some credit unions will require you to have military experience or be a member of a certain service organization to gain membership.
Plus, if you become a member of a federal credit union, you could gain access to a payday alternative loan (PAL). These unsecured loans were designed to help consumers avoid the high interest rates of payday loans — the maximum interest rate charge on them is 28%. The downside is that the terms of these loans are short — they have a repayment term of one to 12 months.
Look into secured loans
If you’re having trouble getting approved for an unsecured personal loan, try taking out a secured personal loan. Unlike an unsecured loan, a secured loan is one that is backed by collateral, such as a car title or cash deposit. The upside of this move is that it can increase your chances of getting approved; however, the downside is that if you fail to repay, the lender can take your collateral.
Enlist the help of a cosigner
You can also consider getting a personal loan with a cosigner. Having a cosigner with a good-to-excellent credit score can decrease your chances of being denied for a personal loan and help you secure a better interest rate. If you find someone who is willing to cosign for you, explain to them that they’ll be responsible for repaying the loan if you’re unable to pay it. Also, let them know that if you make a late payment, their credit score could suffer.
Get prequalified with lenders without hurting your credit
One way to assess your likelihood of being approved for a personal loan with bad credit is to get prequalified with lenders. During the prequalification process, a lender will determine whether you’re eligible to apply for a personal loan by performing a soft credit inquiry, which has no impact on your credit score.
Although getting prequalified is a great way to determine whether you’ll get approved for a personal loan, there is no guarantee that you’ll be approved. However, it’s a good way to compare rates from various lenders, since some of them will give you an estimated APR.