Personal loans are increasingly popular as a debt consolidation tool. When you have lots of credit card debt, one way to improve your credit and your financial well-being is by taking out a consolidation loan with a lower interest rate than you are currently being charged on your credit cards. This is just one of the five most common uses of a personal loan, but is a good example of a personal loan’s usefulness.
However, when you apply for a personal loan, not everyone gets accepted.
Even when they do, the rates and terms for their loan may be much different from the "as low as" rates that are advertised (and only available to people with the best possible credit).
So, what are the reasons that you might get rejected, and what can you do about it?
Usually, if you are applying online, you will get an immediate rejection, but you will be sent a letter explaining which of the eligibility criteria caused your rejection in the mail within the next few business days. Rejection always stings, and rejection related to the very vulnerable topic of your finances can feel incredibly personal and painful. You're probably desperate to know what went wrong.
For this article, we asked personal finance experts to explain why an applicant might be rejected for a personal loan application and what their next steps should be.
Reason #1: Insufficient monthly income
"Lenders want to ensure that you are able to repay the money you are seeking to borrow," explains Nathalie Noisette, Founder of Credit Conversion, a credit concierge company providing tailored credit educational resources. She says, "Repayment potential is determined by inquiring into your annual income. If it is determined you don't make enough money, you may be rejected."
Helen Chen, Director of My Cash Online notes, " A lender wants to know that you will be able to comfortably make loan repayments every month, both for their own security and to comply with lending regulations. You need to show that your income will cover your daily living expenses plus the additional cost of monthly loan repayments."
What can you do about it?
"In addition to making more or asking for less, you could start off with a small loan request at first, establish trust, then ask for more later when you've established good faith with the lender," suggests Noisette. Another idea comes from Chen: "If your income falls short, consider extending the loan term which will reduce monthly repayments, or applying for a lower amount."
Reason #2: Spotty employment history
In conjunction with your income, Chane Steiner, CEO of Creditful adds, "Employment history can also be grounds for rejection. If someone changes jobs often the stability of their income is questionable."
What can you do about it?
If this is the case, Steiner emphasizes the importance of thoroughly listing all of your employment details: "Be sure to include ALL of your income on the application. Maybe you work a weekend or night job part-time. Include that. The additional income could be the difference in securing approval."
Reason #3: Thin credit file or bad credit
"Probably the most common reason personal loan applications are rejected has to do with the applicant’s lack of personal credit history or poor credit history," asserts Todd Christensen, Education Manager, Money Fit by DRS, a non-profit debt relief agency.
"Many lenders use your credit score to determine how high of a default risk you are," explains Noisette. "The higher your score, the lower the risk. The lower your score, the higher the risk. If you are a high-risk borrower, lenders will likely decline your application."
Along the same lines, "If you have missed repayments on other debts or utilities or have no prior credit history, it will be more difficult to get a loan," advises Chen. "Most lenders have options for borrowers with a low credit score, so speak to them about whether there are any other products that may be more suitable for you."
If you don’t have a good credit score, can’t get approved for legitimate subprime credit options, as Chen suggested, or the cost to borrow is too high, you may be looking for more financial options.
What can you do about it?
Trying to get a personal loan with bad credit or no credit "can seem like a Catch-22," Christensen expounds. "How are you supposed to qualify for credit if you can’t get approved?"
It’s time to "clean up your credit," according to Noisette. "Start to reestablish your credit-worthiness and ask for the loan when you have a better credit rating."
But what is the game plan?
As Christensen explains, "The standard methods of building credit (starting local and small, then moving step-by-step from tire store credit to retail and gas through bank or credit union card) typically take a year to build an acceptable credit history. Unfortunately, if someone is needing a personal loan, they probably need the money sooner than later, certainly within a year."
If you have less than a year before you need to try to get approved for personal loan funding, Christensen suggests short-term credit-building strategies: check your credit, look into Experian Boost, see if you can become an authorized credit card user, or check out a credit builder loan, available from various financial institutions.
"Pull your own credit report from AnnualCreditReport.com, check for errors that might be hurting your score (late payments, accounts reporting as collections, incorrect balances, etc.) and then dispute those errors directly through the credit bureaus homepages (Equifax.com, Experian.com, and TransUnion.com).
Look at using Experian’s new, free Boost product to get you 'credit' for your monthly bill paying activities (ex. rent, utilities, cell phone). Experian is the only one of the three consumer reporting agencies (bureaus) to offer such a product, but it is boosting participants’ credit scores by an average of 15 points.
Ask a family member with good credit to add you to their credit card account as an authorized user. Regardless of your own credit rating, being an authorized user has no impact on their rating. You don’t have to use or even see them to receive some of the benefits from your family member’s good credit.
Some credit unions have $1,000 credit builder loans that can give you $500 upfront, place the remaining $500 in a secured savings account, and have you make monthly payments for a year (often requiring direct deposit from your employer) until the $1,000 is paid, plus interest. At that point, you also gain access to the remaining $500."
Reason #4: High debt-to-income ratio (DTI ratio)
Javier Martinez, from Zirtue, a relationship-based lending application that simplifies loans between friends and family explains, "consumers with excessive debt have a higher rate of denial due to their debt-to-income ratio, causing banks to feel concerned about extending additional credit to them."
What can you do about it?
"If you make a lot but owe a lot, a high debt to income ratio may scare a lender off," declares Noisette. In this case, the solution is to "Lower your current debt before reapplying for new debt."
Another type of borrower with a high debt-to-income ratio could be in a different situation: too many existing debts. "A large number of small loans or credit cards spread across different providers can be a warning sign to new lenders," explains Chen. If that sounds more like you, "Consider consolidating your debts into just one or two personal loans and you will be much more likely to receive loan approval," the next time you apply.
Reason #5: Too many declined loans in the last year
"It's considered a ‘hard inquiry’ when you apply for a car loan, credit card, mortgage, or student loan," says Chris Michaels, Founder of Frugal Reality. " Whether you apply and get accepted or not, it is still considered a hard inquiry. Too many applications/inquiries make lenders very nervous you are trying to expand your credit too quickly.
If your available credit expands too quickly, then they start to worry whether you can afford to pay each lender back if you maximize all available credit at once. All inquiries will remain on your credit report for 24 months, but hard inquiries only affect your score for the first 12 months of each inquiry."
What can you do about it?
"Before applying," stresses Michaels, "it's advised to ask each lender the likely outcome given your current income, total and monthly debt, and credit score. This will limit the negative impact to your credit score, help you shop better lending institutions, and provide better outcomes." This type of inquiry is generally considered a pre-qualification and will include a soft inquiry into your credit rather than a hard inquiry. This is better for your credit in the long run.
Bonus credit recovery steps
As a bonus for our readers, personal finance expert Carey Zielke from Realities & Dreams, a website dedicated to helping people chase financial freedom and their dreams, has some advice to share. "If your loan application was denied, the lender is required to send you a notice of adverse action which will detail the reason(s) for rejection," explains Zielke. Once you get that notice, whether by snail mail or email, you will know which factors are holding you back.
If you are denied, Zielke suggests that your initial plan of action should be to "Fix errors on your credit report if there are any."
Next, the intermediate action steps include using collateral, saving up for a down payment, and using a co-signer, although Zielke warns, "I do NOT recommend this, but if necessary use a family member if possible, rather than a friend as this can lead to issues!"
Finally, Zielke's long term steps to help determine that you will be approved the next time you fill out a loan application, are difficult sounding, but pretty fundamental: build your credit, enhance the amount of income you bring in, and "pay down or pay off some of your outstanding debt."
The bottom line
Getting rejected for a loan stinks.
There’s no way around it.
However, there are steps that you can take to avoid this rejection in the future. Simply increasing your knowledge of credit scoring, loan eligibility, and where you stand credit-wise can go a long way to helping improve your eligibility. If you can follow the expert advice in this article, work on establishing or rebuilding your credit, you will increase your chances of approval and a happy ending the next time you fill out a loan application.