Loan eligibility is a measurement tool used by financial institutions to analyze risk. In other words, loan eligibility is the ability of a consumer to convince a financial institution that they can adhere to a repayment schedule and reliably repay the money they borrow.
Every lender has a unique list of requirements that applicants must meet to be eligible for a loan. For example, personal loan eligibility is different from payday loan eligibility. But even if a consumer meets the eligibility criteria a lender sets, their financial background will ultimately determine their repayment terms.
What Factors Do Lenders Consider for Loan Eligibility?
If you are interested in applying for a loan, it’s critical to understand the various factors that financial institutions consider for loan eligibility. Knowing a lender’s requirements allows you to better prepare yourself for the approval process. And this information can help you work on improving certain aspects of your credit history.
A credit score is a three-digit number representing a consumer’s financial risk level. There are different types of credit scoring models, but the one most financial institutions use is the FICO score. FICO scores range from 300 to 850 points. Lenders favor higher points because they indicate financial responsibility and stability.
A FICO score falls into one of five rating categories:
- Poor — 300 to 579
- Fair — 580 to 669
- Good — 670 to 739
- Very Good — 740 to 799
- Excellent — 800 to 850
An excellent credit score is the best rating a consumer can get. However, most lenders are willing to work with applicants that have at least a good rating. If a borrower has a score lower than 670, they may struggle to qualify for loans, housing, and low-cost insurance plans.
A person’s payment history is a crucial part of the loan-qualifying process. Payment history counts for 35% of a FICO score, which makes it the most important category for calculation. Late payments will remain on a credit report for up to seven years. This negative entry may directly affect your ability to get funding in the future.
A late loan payment may get reported to the three major credit bureaus: TransUnion, Equifax, and Experian. Reports of late payments will decrease a borrower’s credit score by a few points. Most financial institutions only report payments that are more than 30 days late, but this is not always the case. In addition, a borrower will have to pay a late fee. The cost of a late fee varies by lender and can increase exponentially if the borrower continuously makes late payments.
One of the best ways to build a strong credit score is to maintain a long history of on-time monthly payments. If you know you will be unable to pay by a specific due date, talk to your lender. It may be possible to get an extension to preserve your excellent payment history.
Lenders generally only provide financial assistance to borrowers who have access to a reliable source of income. Financial institutions take on significant risk when lending money, so they need assurance that a borrower can repay their debt through consistent monthly payments. While some lenders require paycheck stubs, many others accept alternative forms of payment. This means you may still get loan approval if you have an inconsistent payment schedule or do not actively work due to retirement or a layoff.
A debt-to-income (DTI) ratio is a percentage of a borrower’s total outstanding debt in relation to their income. Ideally, a borrower should have a low DTI ratio. When consumers have too much debt, they can become financially unstable and have difficulty meeting existing debt obligations. A high DTI ratio is typically any percentage higher than 50%. Still, every lender may have a unique DTI requirement for loan approval.
To calculate your DTI ratio, you will need to know your total debt amount and your gross monthly income. Gross monthly income is the total amount you receive from employment and other additional income sources. Once you have this information, divide your total monthly expenses from your total income to get your DTI ratio. Suppose you pay $2,300 on expenses every month and earn $5,000. In that case, your DTI ratio is 46%, which may be too high to qualify with certain lenders.
If you apply for a secured loan, the lender will take into consideration the type of collateral you can provide. A secured loan is a loan that requires a valuable asset as security in case of default. During the repayment process, the lender either holds the physical item or gets documentation that gives them temporary ownership. The borrower regains possession of their asset once the debt is repaid in full.
Since secured loans lower the risk for the lender, it may be easier for a low-credit borrower to obtain approval. The type of collateral you can use depends on the type of loan and the lender. For example, certain loans require specific assets, such as auto loans or mortgages. But if you want to apply for a secured personal loan, you may be able to use different kinds of collateral.
These are a few items that loan lenders typically accept as collateral for secured personal loans:
- A boat or car title.
- Stocks or bonds.
- Jewelry or precious metals.
- Collectibles that have a high value.
- Cash in a savings account.
- Cash in a certificate of deposit (CD) account.
What Documents Do I Need To Meet Loan Eligibility?
If you are interested in applying for a loan, you must be ready to provide a few documents and personal details. Remember there are usually two ways to apply for emergency funding: in-person and online.
The online approval process for loans tends to be simpler and faster because travel is unnecessary. To apply for an online loan, you generally have to submit an online application form with your personal information and complete a bank verification process.
A bank verification process is required to verify that the bank account belongs to you. The lender may ask for your bank name, account number, and routing number. Or you may have to log into your bank account through a secure connection. Rest assured that legitimate financial institutions take steps to ensure your data is kept secure, such as using encryption.
You will have to fill out and submit an application to officially apply for a loan. The form will ask for basic personal information, such as your name, date of birth, address, email address, etc. This form may ask how much funding you need, but remember you are not guaranteed to get the full asking amount.
Proof of Identity
An applicant is required to provide proof of their identity to get a loan. You will need a government-issued photo ID. The exact identification cards you can use depend on the lender, but most lenders accept driver’s licenses, state IDs, and U.S. passports. If you apply for a loan with online lenders, you may have to provide a Social Security Number (SSN) or alternative identification number instead of a physical document.
You must have some form of income to get approval for a loan. The list of acceptable income documents varies by lender, but typically applicants use weekly or biweekly paycheck stubs. If you are unemployed or do not receive recurring income, know that you may still qualify for a loan if you can show proof of your ability to make monthly payments.
Some financial institutions accept alternative income documentation, such as:
- Bank statements.
- Money in an investment account.
- Government award letters.
- W2s or recent tax returns.
- An employment contract.
Proof of Address
There are various documents you can provide to a lender in order to show proof of residence. The paperwork you provide must have your full legal name and exact address. Most borrowers use recent utility bills, credit card statements, insurance statements, tax returns, etc. Contact your lender for a full list of acceptable residential documents.
How Can I Improve My Credit Score and Loan Eligibility?
Increasing your creditworthiness is the best way to improve your loan eligibility. Credit scores are numerical representations of your credit history, which is why many lenders rely on them to make approval decisions. One of lenders’ most commonly used credit scores is the FICO score.
A FICO score is determined through the calculation of these five financial categories:
- Payment History (35%) — Your payment history is the most critical factor for credit score calculation. Late payments signal to financial institutions that managing your personal finances is challenging.
- Total Debt (30%) — Your total debt makes up 30% of your credit score. Carrying too much debt can be financially detrimental and negatively impact your score. Working on repaying your existing financial obligations while avoiding new loans may improve your creditworthiness.
- Length of Credit History (15%) — The longer you keep financial accounts open and in good standing, the better your credit will be. Responsibly maintaining an account for years can help you appear financially stable to future lenders.
- New Credit Inquiries (10%) — The number of inquiries you make for new loans. Making more than six inquiries within a year can negatively affect credit scores.
- Credit Mix (10%) — The type of loans you have can positively affect your credit. A mix of installment and revolving credit accounts shows you are capable of managing your finances.
What If I Am Not Eligible for a Loan?
Need a new loan to cover the cost of an unexpected bill or expense? Unfortunately, a lender can determine an applicant is ineligible. If you submit a personal loan application and get denied, you may feel blindsided. The good news is that you may still have options!
Review the Reason for the Loan Denial
If a financial institution determines that you do not qualify for a personal loan, the Fair Credit Reporting Act requires financial institutions to send an adverse action letter if a negative decision is credit-based. An adverse action letter is a document that details specific decisions, such as approval denial or an interest rate increase. Receiving an adverse action letter does not negatively affect one’s credit score. However, the process of applying for a loan and undergoing a hard credit check may have already decreased an applicant’s credit score.
If a lender’s negative decision was not based on a consumer’s credit report, they must still receive an explanation. Federal law requires the Equal Credit Opportunity Act to provide a detailed explanation as to why they made an adverse action to a consumer or business. Knowing why a lender deemed you ineligible for funding can help you determine what changes you need to make in order to qualify for funding in the future.
Apply for Bad Credit Loans
Suppose you apply for an unsecured personal loan and do not meet the qualifying criteria. In that case, you may try applying for bad credit loans. Bad credit loans generally have low credit requirements, which means a consumer does not need perfect credit to qualify for emergency funding. But keep in mind that bad credit loans typically have higher interest rates, so it’s a good idea to shop around and compare loan terms before applying with a lender.
Work on Improving Your Credit
The best way to improve your loan eligibility is to work on building a strong credit score. A high credit score assures a financial institution that you are financially responsible and can be trusted to meet all debt obligations. In addition, a good credit score can help you acquire better loan terms, such as a higher credit limit and a lower interest rate.
What is an adverse action notice?│Lexington Law