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Know what it takes to get approved for a loan
When you find that perfect house, car or other major purchase and decide to apply for credit, you’ll complete an application for your bank. For many consumers that’s where the mystery begins. Just what is important most to lenders? To find out, look at it from their perspective.
Lenders follow strict guidelines in the decision-making process to ensure all applicants are fairly reviewed solely on the merit of their credit-worthiness to determine if borrowers are ready for the responsibility of repaying a loan.
Your lender will review four key elements, commonly called the “Four Cs,” to evaluate the amount of risk in loaning you money—too much risk and you may be declined. High-risk could mean you’re approved with a higher interest rate or with other restrictions. Here’s how to understand the Four Cs:
Character: This reflects your attitude and values related to credit commitments. Character is evidenced in your track record. Do you consistently repay your existing obligations? For example, a history of on-time mortgage payments is considered a good predictor. People with high credit scores have a dedication to repay all their debts on time. Also, are there judgments, tax liens, foreclosures or bankruptcies?
Capacity to Pay: Do you have ongoing income to make the payments? What is your disposable income after all regular monthly obligations are met—is there a cushion remaining? Lenders understand there are always unforeseen expenses, and that’s factored in.
The most common representation is “debt ratio” (total monthly debt divided by income). Generally, this should be less than 50 percent and as low as 36 percent for some types of loans. Another consideration is the amount of time you’ve been at your job or working in the same career (minimum of two years is often a prerequisite). Those with a stable job history are a lower risk.
Capital: This references your assets. Plainly stated, your property and other valuables are considered an indicator of your ability to make a living. Liquid assets, those that can be readily turned into cash, are the most important since they can be used to meet credit obligations. This includes checking, savings, stocks, bonds, mutual funds, CDs, and retirement accounts like 401k accounts. Some are more liquid than others and the values may be adjusted accordingly.
If the worst happens, like loss of a job, your ability to access funds reduces the risk that you’ll miss payments. Lenders look closely at how many months you can pay your debts—including the new loan—with these liquid assets. If you have assets that generate a monthly income, they are also factored into your Capacity to Pay.
Collateral: On a mortgage or car loan, the item financed is security for the loan. In a worst-case scenario, the lender may have to foreclose on the property or repossess a car and sell it, using the proceeds to pay-off the loan. On other types of loans the collateral is a huge factor, especially second mortgages and home equity lines of credit, so the lender will look at the value of the home and how much you owe on it.
Know that your lender wants you to be successful—to purchase that item, make the payments and have a positive experience. Once you get a loan, the rest is up to you to make that happen.
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