Getting turned down for a loan can be awkward. You put yourself out there to ask for money, provide highly personal information, back it up with private documents. It stings when the lender declines your application.
You might feel angry, disappointed or embarrassed, but it’s not the end of the world. It’s important to understand that lenders tend to focus on different types of borrowers and turn down people who don’t fit their box. One company might reject you while another begs for your business. The roadmap below shows you how to get over rejection, choose the right lender and put your best foot forward.
Step 1: Read your adverse action notice
Your first step after being denied a loan is to read your “adverse action notice.” The Fair Credit Reporting Act and the Equal Credit Opportunity Act require lenders to issue this notice orally, electronically or in writing when they deny your credit application or offer less favorable terms like a lower loan amount.
By law, adverse action notices must contain this information:
- The name, address and phone number of the credit bureau (including a toll-free number for nationwide agencies) that supplied the report.
- A statement that the credit bureau doesn’t make underwriting decisions and can’t explain why the lender declined your application.
- Notice that you have the right to a free copy of the credit report used if you request it within 60 days.
- Notice of your right to dispute the accuracy or completeness of any information on the credit report.
- Your credit score, if a score was used.
The lender is also required by law to provide the specific reason(s) you were turned down for a loan or explain where to get that information (you must request it within 60 days).
Common reasons for loan denial
Once you understand the reason for your loan denial, you can address it. Here are the top reasons lenders deny credit:
- Poor credit history. If your track record with previous lenders features missed payments, charge-offs, collections or other blemishes, future lenders will be reluctant to trust you.
- Insufficient credit history. While having no history is better than bad history, it’s still a big hurdle to overcome. Lenders can’t predict your future behavior without some past behavior to analyze.
- High debt-to-income ratio. Your debt-to-income ratio (DTI) shows lenders how much of your income is available to repay a new loan. If you already owe more than you can safely repay, you may have difficulty borrowing additional funds.
- Spotty employment history. It takes income to pay bills, and if your earnings are inconsistent, lenders worry that you won’t be able to repay your loans. Lenders like to see stable, consistent, healthy income and not big gaps between jobs, frequent employer or industry changes or income that’s dropping.
- Incomplete or inaccurate application. Lenders can’t make a decision if you don’t complete the application and supply all requested documentation.
Don’t be discouraged. You can address these issues, improve your profile, and probably get loan approval.
Step 2: Fix what you can
Once you know why a lender turned you down, you can work to improve your chances.
Credit report errors
Review your credit report for accuracy and correct errors if needed. Contact the company that reported incorrectly or report the error to the credit reporting agency on its website. If your application is for a mortgage, your lender may be able to help you correct errors very quickly by using a rapid rescoring service.
Go through your loan application and make sure that you provided complete and truthful information. Look at your debts. Many times, lenders take the balances and payments right off of your credit report. If the actual balances and payments are lower, document them for your lender. Make sure your income is also calculated correctly.
A spotty work history with gaps and changes raises red flags with lenders. There are a few acceptable reasons for such changes, for example being in school, switching to part-time after having a baby, moving for a spouse’s job, or changing careers after completing your education. You may be able to overcome job instability with a stellar credit history, conservative use of debt, or a healthy emergency fund. If you have had job changes in the last two years, try to tie them together to build a picture of steady work doing a similar job or working in the same industry.
Minimum credit score
If your credit score is the problem, you can (and should) work toward improving it over time. But you should also look for a lender with lower minimum credit score requirements. Check your credit score and ask lenders what their guidelines are before applying. Or seek out lenders that offer a loan prequalification without pulling your credit.
Debt to income
If your issue is debt-to-income, you can fix that by paying down debt, increasing your income (side gig?), or choosing a lender that allows higher ratios.
To calculate your DTI, add up your housing costs (mortgage payment or rent) and your monthly debt payments including credit card minimums, auto loans, student debt, etc. Don’t include living expenses like utilities or food. Divide that total by your monthly before-tax income. To approve you, a conservative lender won’t want your DTI over 36%, an average lender maxes out at 43% and a generous one at 50%.
Step 3: How to get a loan with bad credit or high DTI
Of course, you want to improve your financial management and credit score for future borrowing. But what if you need money now?
Consider non-prime lenders
There are lenders and credit card issuers that specialize in riskier borrowers. They might be willing to accept a lower credit score if your income is sufficient to afford the loan. Some personal loan companies are willing to accept credit scores as low as 580 for otherwise-qualified applicants. Shop carefully for non-prime loans because interest rates and terms vary wildly. Make sure you can afford the payments and that you have a plan for paying off the loan. Missing payments can drag your credit score even lower and get you into more financial trouble.
Loans backed by collateral that the lender can take are less risky to lenders. You may be able to get financing by pledging something valuable like real estate, a car, electronics or jewelry. Beware of auto title loans, however. They often have extremely high rates and your balance increases very quickly if you don’t repay it right away. You can even lose your vehicle.
Get a co-borrower or co-signer
If you have loved ones with good credit, you might be able to bring in a co-signer or co-borrower. Lenders consider all applicants’ income and debts, so another borrower can help if your income is low. And adding someone with better credit to the application could get you a better deal.
However, co-signing or co-borrowing can be extremely dangerous for your friend or family member. If you miss a payment, it will likely hurt their credit score. If you default on (don’t pay) your loan, your lender may pursue your loved one for payment, even into court if necessary. Co-signing also creates contingent liability for your cosigner, which means they might have to pay your debt. This can make it harder for them to get credit in the future. If your friend or relative is willing to take this on, cherish them and do not abuse their trust. Such a relationship is worth more than any amount you can borrow.
Does being declined for a loan hurt your credit score?
Being denied credit does not directly harm your credit score. Lenders do not report their underwriting decisions to credit bureaus.
That said, applying for credit triggers a “hard” inquiry when the lender pulls your credit report, and a hard inquiry causes your credit score to drop a few points. So-called “soft” inquiries happen when you check your own credit or prequalify for credit without applying. Soft inquiries don’t harm your credit score.
So, if you apply for loans everywhere and get denied repeatedly, you have a batch of hard inquiries. Statistically, consumers with at least six inquiries are eight times more likely to go bankrupt, so they raise red flags with lenders. It’s smart to prequalify for loans without a hard inquiry or ask lenders what their guidelines are before applying for credit.
How long do inquiries hurt your credit score? They remain on your credit report for two years but only impact your score for 12 months.
Understand that credit bureaus treat inquiries for auto loans and mortgages differently. That’s because you often don’t know what interest rate and terms you may be offered until you apply. And it’s common for consumers to apply with several lenders when shopping for financing. So as long as you do your shopping within a short timeframe (14 to 45 days depending on the scoring model version), your credit score reflects only one inquiry.
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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.