Whether you’re ready to pursue a long-term financial goal like buying a home or new car, are ready to pull the trigger on a home renovation, or simply want to become more aggressive in paying down high-interest credit card debt, there are many types of loans that could help you access the cash you need to achieve those ambitions.
You’ve probably seen and heard advertisements touting specific interest rates or guaranteed loan approval, but the fact is, not all loan applicants are approved, and not all are offered the most competitive rate. The more you understand about the factors that play a role in lending decisions, the better financial picture you can paint on your own loan application.
Consider these factors in your financial life so you can strengthen your case as an attractive loan candidate.
Know What’s in Your Credit History
Your credit history is essentially a compilation report of the many different aspects of your financial life. It includes information about credit accounts you own, like credit cards, student, auto and mortgage loans. Your credit history also includes information about whether you pay bills on time, if you’ve missed payments or defaulted on loans and the amount of debt you have relative to your available credit. Just as you might use online reviews, testimonials from other customers or a rating by a consumer advocacy group like the Better Business Bureau to determine if a merchant or service provider is credible and trustworthy, a credit history helps banks determine how much risk they could bear by lending you money, based on your financial behavior. You're entitled to view a free copy of your credit report each year at AnnualCreditReport.com.
Understand How Your Credit History Impacts Your Credit Score
Credit scores are often referred to as FICO or VantageScores (the names of two popular credit scoring bureaus), but there are many credit scores that are industry-specific, based on the type of loan you seek. Because of this, credit scores may vary slightly, but most are based on a few specific pieces of criterion, based on the information in your credit report/history. These include:
- Bill payment history. Banks want to know customers will repay loans as agreed, so this element is an important factor in determining your trustworthiness as a borrower. A missed payment can stay on your credit report for several years. If you intend to apply for a loan in the future, commit to paying bills on time. Once you’ve established a history of making on-time payments for several months, missed payments of the past may have less bearing on loan decisions.
- Balances on your credit accounts. High credit balances (compared to your available credit line) may cause lenders to perceive you as a borrower who relies too much on credit, due to lack of cash. You can make yourself a more attractive loan candidate by paying your credit card balances down so they don’t exceed more than half of your available credit line (and maintaining them at that level) for several months before you apply for a loan.
- The length of your credit history. The credit or loan accounts you’ve owned the longest typically have the greatest impact on your credit score. If you don’t have an established credit history, you may want to consider opening a secured credit card to help build your credit history well in advance of applying for a loan. Avoid applying for new credit accounts when you intend to apply for a loan. Too many new accounts opened in a short period of time can negatively impact your credit score.
Confirm That You Have Steady Income (and Proof of It)
Banks want to know that you have a steady source of income, supported by documentation like past filed tax returns, and recent paycheck stubs. The longer you’ve been employed at your job or have owned a business, the more reassurance the lender has that your income source will continue.
View Your Debt-to-Income Ratio Like a Bank Would
Banks often require that applicants have no more than a 43% debt to income (DTI) ratio to feel comfortable that the borrower has the financial ability to repay a loan as agreed. Calculate your DTI ratio several months before you’ll apply for a loan so you know where you stand: Add all your monthly debt payments and divide them by monthly income, before taxes and deductions are taken out.
For example, if your mortgage is $1,400 a month, your car payment is $300 and your student loans are $400, your monthly debt payments total $2,100. If your gross monthly income is $5,000, your debt to income ratio is 42%. (Total debt divided by gross monthly income). If your DTI exceeds 43%, make a plan to pay down debt, or supplement income before you apply.
Take Inventory of Your Assets
Lenders may consider assets as an additional source of reassurance that you’ll pay the loan as agreed. Assets can be actual items of value (like a car or property that you own outright), or liquid assets like money in a checking or savings account, or investments.
Consider Your Loan Type, Length and Amount Before You Apply
A loan that’s tied to an item of value (like a mortgage, auto or home equity loan) may be viewed differently by banks than one that isn’t (like a loan that will be used to pay down credit card debt). The more you borrow, the greater the risk that you may not repay the loan as agreed. Borrow only what you really need (and are confident you can repay). Making a substantial down payment towards the loan or tying it to some sort of asset that you would lose if you defaulted on the loan can also give banks reassurance that you’re a quality loan candidate.
Organize Your Financial Records
A bank may ask you to provide a number of documents that substantiate the income, debt and assets you report on your loan application, including past tax records (going back several years, in some cases), paycheck stubs and account statements for deposit, investment and retirement accounts. Because the underwriting and approval process can take several weeks depending on the loan type and lender, gather the documents now so you have this information ready to provide if requested.
When you’re ready to apply for a loan, Fifth Third offers a range of borrowing options to help support your financial life.