Wednesday Welcome: Low Credit Score? Other Factors in the Loan Approval Process
Welcome this week to Tarra Jackson, a financial coach, author and former VP of lending for a financial institution in Delaware. We thought she could offer a unique perspective inside the credit approval process. Particularly if you have a few blemishes on your credit history, this post is for you!
Have you or someone you know ever wondered what lenders are actually looking for to approve someone with less than perfect credit for a loan? I have…
The reality is … not everyone has A+ credit (usually a credit score of 700 or higher). Actually, 47% of the US population has a credit score less than 700 and 20% of the US population has a credit score less than 600*. Does this mean that those with “colorful” or less than perfect credit will not be approved for a loan? Or that they have to go to alternative lenders (Buy Here Pay Here, Title Loans, Payday Loans, etc.)? Absolutely not!
Over my 10 years of financial services experience and career has been as a lender. Most people have heard about the 5 C’s of Credit (Character, Capacity, Collateral, Creditworthiness, & Conditions). Well, here are the top five things that I and other lenders really look at to approve a loan for applicants with less than perfect credit.
- Relationship. Most financial institutions/lenders look at the financial relationship the applicant has with them. Does the applicant have deposit accounts (checking or saving accounts, CDs) with the financial institution? What services does the applicant utilize with the financial institution (online banking, debit card)? Has the applicant ever caused the financial institution a loss (unpaid overdrawn checking account, past loans unpaid, etc.)? The more the applicant is committed to the financial institution by having deposits, using other services, or paying past loans on time, the better.
- Stability. Lenders look for how stable the applicant is with their residence and especially their employment. The longer the applicant has lived at their residence and job, the better. Stability is a sign of consistency and responsibility. Lack of stability, which is identified by frequent changes in residence and employment, may be a red flag.
- Low debt-to-income ratio. Debt-to-income ratio tells the lender how much of a payment the applicant can afford to pay monthly. The debts that are taken into consideration are mainly reported on the applicant’s credit report. The debt that may not report on the credit report that is used to calculate the debt-to-income ratio is the applicant’s rent. The debt-to-income ratio is calculated by dividing the total income into the total amount of monthly payment expenses in the credit report, plus rent/mortgage (if not reported in the credit report). Some lenders use the applicant’s gross income (before taxes and other deductions are taken out) when calculating this ratio. However, applicants use their net income (after taxes and other deductions are taken out) to pay their bills. It is recommended that the applicant knows how much they can afford based on their net income and all current expenses, including expenses that are not reported in the credit report (such as utilities, childcare, etc.) are taken into consideration. A debt-to-income ratio of 40% or less may help the applicant with less than perfect credit.
- Collateral. The type of loan (auto, unsecured, credit card) the applicant is applying for may determine what type of collateral needed. The value of collateral may play a significant role in the lender’s decision. Even if the applicant is applying for an unsecured loan or credit card, the lender may recommend or require collateral, such as a vehicle free and clear of any loan or lien or cash, to reduce the “credit risk.” Credit risk is the loss of principal or loss of income from a borrower’s failure to repay a loan. The collateral reduces the credit risk for lender.
- Payment history. Of course the obvious is credit history. But, some financial institutions look beyond the score and read the credit report to see the full picture. They look at the applicant’s credit report to see how they paid other creditors. This is important because the payment history with others may be indicative of how they will pay future lenders. Paying existing creditors on time, even if there were some credit mishaps in the past, may show the lender that the applicant now has the ability to pay their bills.
Clearly, not everyone with less than perfect credit will get approved, but this insight may help with understanding that there are some lenders out there that do not just judge all applicants solely by their credit score. So, before apply for a loan, ask the lender if they take any of these things into consideration with their credit approval process.