Why Your Bank Loan Was Denied or Approved: What Do Loan Officers Look For?
Your Credit Application
Whether you are applying for a mortgage, a credit card, or a car loan, banks and credit unions are going to be looking for the same thing—how much risk they will take on if they approve your loan. They want to know if they will risk losing money by granting you the loan, or rather, if you will pay the loan and any accrued interest back to them. Financial institutions earn money by charging interest on the loans they extend. But they lose money when loans "go bad" and aren't paid back. They want to avoid as many of these bad loans as possible.
Basically, whether you get approved or denied for a loan depends on how much risk the financial institutions is willing to take on and how risky your credit application looks. If your loan is approved, the interest rate you are given will also be based on your potential risk to the financial institution. The more risk (or chance you will default on your loan), the higher the loan is going to cost you through the interest rate if you are approved. You can swear that you will pay back a loan, but the sad truth is that people lie and the financial institution can't tell which ones are honest and which ones aren't. Even people that truly mean to pay back loans sometimes fall into situations where they aren't able to. Your loan application is the best indicator a bank or credit union has for whether or not you are going to pay back a loan and what interest rate they should charge.
Every financial institution has their own loan policies and specific numbers they use to determine if your loan is approved or denied and these numbers and guidelines will change based on the economy and on their business needs. Having a strong credit application will help ensure your application is always approved. After working in the financial industry for many years, including as a loan officer, I can tell you some of the things a loan officer will look at when they review your loan application and what things can help or hurt you.
Your credit score is the quickest tool a loan officer has for determining what your credit risk is. Scores can range from around 400 to 850. The higher your score, the better. If you haven't had a lot of credit experience, it is possible that you won't have a score. This isn't a negative thing, but it doesn't help either. To get the best rates and to help approve your loan, you'll probably want a score in the 700s or higher. Scores in in the low 600s or lower don't look good to a loan officer. When you request your score (also known as a FICO score), be aware that it is not necessarily the same score that your loan officer will see. Each financial institution can use their own standards for determining your score.
Your credit score is determined by the items on your credit history. Your credit history is not an indication of whether or not you will repay a loan, but it does show a history of how you have operated in the past and the past is a good indicator of the future. It is probably the most important thing the loan officer will look at. You can check your credit histories for free from each of the major credit bureaus once a year by going to AnnualCreditReport.com. This is set up through legislation by the government to help fight identity theft. It's a good idea to check your credit report in advance for applying for a loan so you can see if there is anything that needs to be cleared up (such as mistakes or identity theft issues).
They will want to see that you have had experience with credit and have made on time payments. Late payments showing on your credit history look bad, especially since they usually only show up if you were more than 30 days late. A late payment on a mortgage looks worse than a late payment on a credit card, since a loan officer would expect a higher priority to be placed on your home. The loan officer will see how long you have had experience with credit by looking at the date your earliest account was opened. The more time, the better. And the more on time payments you have, the better.
Other things that could show up on your credit history include collections, judgements, and garnishments. These are big red flags to a loan officer. Obviously, it is best to avoid these, but if one of these show up on your credit history and you have a reasonable explanation for it, let the loan officer know. They can sometimes make exceptions for these items, but they'll need a really good reason to overlook them. If you are aware of any of these items on your credit history, pay them! It will show up as paid on your credit (which will also reflect in your credit score). A paid collection or judgement always looks better than an unpaid collection or judgment.
Some judgments come from lawsuits. If you are in court and are ordered to make payment, ask the judge if you can pay it right then. If you do, you may be able to avoid it ever showing on your credit history.
Bankruptcies and foreclosures also show up on your credit history. These are biggest red flags to loan officers because it can indicate serious financial mismanagement. It also shows other (sometimes large) loans that have gone unpaid. Remember, loan officers are looking at your past to determine your performance in the future. The best thing to do if you have either of these on your credit is making sure you handle your finances prudently from here on out by always making your payments on time. These items can stay on your credit report for 7-10 years. If there was an unusual circumstance behind your bankruptcy or foreclosure, that would no longer have an impact on your finances now, let the loan officer know. An example of this would be a medical illness that you no longer have. Loan officers can sometimes make exceptions, but not always, but give them the information they need to make a case for you.
Above all, a history of on-time payments is the best thing for your credit report. Having a variety of different types of credit (car loan, credit card, etc.) helps a little to, but is not nearly as important as showing that you can consistently make payments on time.
Another aspect of your credit application is your employment history. The financial institution will want to make sure that you are receiving and will continue to receive the money you will need to pay back their loan. The longer you are at the same job, the more secure it seems. Changing jobs right before you apply for a loan (or worse, while you are applying for the loan) makes loan officers cringe. They want to see that you have are secure in your employment. The first few months a person is at a new job is when they are at greatest risk of losing their job, either because of lay offs or because they aren't a good match for the company. Showing that you have been with the same employer for years is optimal. But don't fret if you haven't been at your job that long, your employment history isn't nearly as important as your credit history. If you have switched jobs, but have stayed in the same field, most loan officers will consider that the same line of employment.
Debt and Income
The next part of your credit application that a loan officer will consider is whether or not you can afford to make the payment on the new loan. This is one area where people with good credit history often get caught up on. The loan officer is going to look at all your debts and then compare this to your income. They will determine your debt-to-income ratio, or rather how much of your income is being spent on debt payments. Usually when you fill out your credit application, they will ask you to list your debts (other loans and obligations), but even if you don't, they will probably see it on your credit history. The loan officer may ask to verify your income to make sure you are making what you say you are making. The loan officers will assume that a certain percentage of your income is going to go to living expenses (food, etc.). They will want to keep your debt compared to your income at a certain amount to make sure you can handle your expenses. The amount allowed sometimes is correlated to the risk you represent from your credit history. If your credit looks a little more risky, then they aren't going to allow as much debt. If you have a strong credit history, that shows reliability and they may allow for a higher debt-to-income ratio. If your loan is denied for this reason, work on paying off debts or at least lowering your monthly payments or waiting until your income increases. Sometimes people will get a raise and immediately go apply for a new loan, but loan officers usually look at your average income, so unless they are certain you will stay at the higher amount, they are going to use your average. If you can, wait until your raise has been in effect for a couple months before you apply.
There are two types of loans, secured loans and unsecured loans. Secured loans are ones that have physical property to back up the loan, such as a house or a vehicle. The property is called collateral. Loan officers like these types of loan because if you fail to pay the loan, there is property secured, usually through a lien, to the loan. That means that they would have a right to take or repossess the property. This provides some protection to the financial institution because it gives them an asset they could sell to recoup the loan and their expenses with trying to collect the loan. Unsecured loans are loans that do not have any property tied to them. Examples of this type of loan are credit cards and signature loans. These loans are more risky for the financial institution because if you stopped making payments on your loan they wouldn't have anything they could use to recover the loan amount. However, these loans are not usually for large amounts like secured loans can be. Interest rates on unsecured loans are usually higher than on secured loans because there is more risk for the financial industry.
For secured loans, the loan officer is going to look at the value of the collateral. They will want to make sure the collateral is for at least the amount of the loan. They may sometimes allow the loan to be more than the value of the collateral if the rest of the application is strong. If you have a couple problems with the rest of your credit application, or if you don't have a lot of credit experience (reflected in your credit history), using collateral with more value than the amount you are requesting for in the loan is a good way to make up for it. You can do this by making down payments. The more value you have in your collateral compared to the amount you are requesting, the better it is for your application.
The thing to keep in mind when applying for loans is that the financial institution isn't wanting to deny your loan, but for their sake and the sake of their customers, they have to manage their risk. Even if one bank denies your loan, that doesn't mean a different bank would. However, if you have some of the problems listed above, work to correct them and it will be easier. A strong application is built in the long run by developing a history of responsibility and reliability.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.