Credit plays a big role, but it is not the only decisive factor.
You want to put your best foot forward when applying for a mortgage, car loan or personal loan, but this can be difficult if 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 take into account when deciding whether or not to partner with you. Here are seven you should be aware of.
1. Your credit
Almost all lenders look at your credit score and report because it gives them insight into how you handle borrowed money. A bad credit history indicates an increased risk of default. This deters many lenders as they may not get back what they loaned you.
Scores range from 300 to 850 with the two most popular credit score models, the FICO® score and the VantageScore, and the higher your score, the better. Lenders don’t usually 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 years 700 or 800.
2. Your income and employment history
Lenders want to know that you can repay what you borrow, and as such, they need to make sure you have adequate and consistent income. Income requirements vary based on the amount you borrow, but if you borrow more money, lenders will typically need to see higher income to make sure you can keep up with payments.
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You must also be able to prove permanent employment. Those who only work part of the year or are self-employed who are just starting their career may have more time to get a loan than those who work year-round for an established company.
3. Your relationship between debt and income
Closely related to your income is your debt-income ratio. This looks at your monthly debt obligations as a percentage of your monthly income. Lenders like to see a low debt-to-income ratio, and if your ratio is greater than 43% – so your debt payments don’t make up 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-income ratio higher than this amount if your income is reasonably high and your credit is good, but some lenders are more likely to turn you down than take the risk. Work on paying off your existing debt, if you have it, and bring your debt to income ratio down to less than 43% before applying for a mortgage.
4. Value of your collateral
Collateral is something you want to give to the bank if you can’t keep track of your payments. Loans involving collateral are called secured loans while loans without collateral are considered unsecured loans. Secured loans usually have a lower interest rate than unsecured loans because the bank has a way to get its money back if you don’t pay.
The value of your collateral partly determines how much you can borrow. For example, if you buy a home, you cannot borrow more than the current market value of the home. That’s because the bank needs the security that it can get all of its money back if you can’t keep track of your payments.
5. Size of the down payment
Some loans require a down payment, and the amount of your down payment determines how much money you need to borrow. For example, if you buy a car and pay more in advance, that you need to borrow less from the bank. In some cases, you can get a loan with no down payment or with a small down payment, but understand that you will pay more in interest over the life of the loan if you go this route.
6. Cash and cash equivalents
Lenders would like to see you put some cash in one savings or money market account, or assets that you can easily turn into cash on top of the money you use for your down payment. This assures them that even if you experience a temporary setback, such as the loss of a job, you can still keep track of your payments until you get back on your feet. If you haven’t saved a lot of money, you may have to pay higher interest.
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7. Loan term
Your financial circumstances may not change that much over the course of a year or two, but over the course of 10 or more years, your situation may change a lot. Sometimes these changes are for the better, but when they are worse, they can affect your ability to repay your loan. Lenders will usually be more comfortable lending money for a shorter period of time because you are more likely to be able to repay the loan in the near future.
A shorter loan term also saves you more money because you pay less years of interest. But you’ll have a higher monthly payment, which is why you’ll need to weigh this up when deciding which loan term is right for you.
Understanding the factors that lenders consider when evaluating loan applications can increase your chances of success. If you think any of the above could hurt your chances of getting approval, take steps to improve it before applying.