Loan Approval Factors: What Lenders Really Look For

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Credit plays a big part, but it's not the only deciding factor.

You want to put your best foot forward when applying for a mortgage, auto loan, or personal loan, but this can be difficult to do when 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 consider when deciding whether to work with you. Here are seven that you should be aware of.

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1. Your credit

Nearly all lenders look at your credit score and report because it gives them insight into how you manage borrowed money. A poor credit history indicates an increased risk of default. This scares off many lenders because there's a chance they may not get back what they lent you.

Scores range from 300 to 850 with the two most popular credit-scoring models:

• The FICO® Score
• The VantageScore

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 700s or 800s.

2. Your income and employment history

Lenders want to know that you will be able to pay back what you borrow, and as such, they need to see that you have sufficient and consistent income. The income requirements vary based on the amount you borrow, but typically, if you're borrowing more money, lenders will need to see a higher income to feel confident that you can keep up with the payments. 

You'll also need to be able to demonstrate steady employment. Those who only work part of the year or self-employed individuals just getting their careers started may have a harder time getting a loan than those who work year-round for an established company.

3. Your debt-to-income ratio

Closely related to your income is your debt-to-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 take up no 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 that's more than this amount if your income is reasonably high and your credit is good, but some lenders will turn you down rather than take the risk. Work to pay down your existing debt, if you have any, and get your debt-to-income ratio down to less than 43% before applying for a mortgage.

4. Value of your collateral

Collateral is something that you agree to give to the bank if you are not able to keep up with your loan payments. Loans that involve collateral are called secured loans while those without collateral are considered unsecured loans. Secured loans usually have lower interest rates than unsecured loans because the bank has a way to recoup its money if you do not pay.

The value of your collateral will also determine in part how much you can borrow. For example, when you buy a home, you cannot borrow more than the current value of the home. That's because the bank needs the assurance that it will be able to get back all of its money if you aren't able to keep up with your payments.

5. Size of down payment

Some loans require a down payment and the size of your down payment determines how much money you need to borrow. If, for example, you are buying a car, paying more up front means you won't need to borrow as much from the bank. In some cases, you can get a loan without a down payment or with a small down payment, but understand that you'll pay more in interest over the life of the loan if you go this route.

6. Liquid assets

Lenders like to see that you have some cash in a savings or money market account, or assets that you can easily turn into cash above and beyond the money you're using for your down payment. This reassures them that even if you experience a temporary setback, like the loss of a job, you'll still be able to keep up with your payments until you get back on your feet. If you don't have much cash saved up, you may have to pay a higher interest rate.

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, it's possible that your situation could change a lot. Sometimes these changes are for the better, but if they're for the worse, they could impact your ability to pay back your loan. Lenders will usually feel more comfortable about lending you money for a shorter period of time because you're more likely to be able to pay back the loan in the near future.

A shorter loan term will also save you more money because you'll pay interest for fewer years. But you'll have a higher monthly payment, and so you must weigh this when deciding which loan term is right for you.

Understanding the factors that lenders consider when evaluating loan applications can help you increase your odds of success. If you think any of the above factors may hurt your chance of approval, take steps to improve them before you apply.

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