Before you apply for a loan, it’s useful to have a solid understanding of the factors lenders consider when deciding whether to approve or deny your application — and how much they’ll ask you to pay in the form of interest charges. Since applying for loans does count as a hard inquiry on your credit report, it’s ideal to submit as few applications as possible to secure the funding you need. This is because hard inquiries can temporarily ding your credit score.
Here’s more on how lenders assess borrower risk and how borrowers can make their loan applications as strong as possible upfront to maximize their chances of getting approved.
Factors Lender Consider When Evaluating Loan Applications
The experts at Inc. identify five leading factors lenders assess during the process of evaluating and approving loan applications.
Creditworthiness: If credit hasn’t yet seemed to play an outsized role in your life, here’s where that may change. Creditworthiness describes how likely to pay back your obligations lenders believe you are and is based heavily on the factors that make up your credit score — like payment history, percentage of available credit being utilized, a mix of credit types, length of credit history, and more.
Not only does creditworthiness majorly affect whether lenders will say “yes” or “no” to loaning you funds, they’ll also offer lower interest rates to applicants with stronger credit standings. On the flip side, borrowers with poor credit will have a harder time getting approved and will be asked to pay more in interest. Say you’re trying to take out a personal loan to pay down the rest of your debts. Debt consolidation for bad credit tends to cost more than securing a consolidation loan with good credit. The same principle applies across the board for loans.
Amount of debt: This is where lenders look specifically at your debt-to-income ratio to assess how much you owe vs. how much you make, taking into consideration all different types of debt burdens.
Size of loan: How much you’re asking to borrow will affect the amount of risk the transaction represents from the lender’s perspective. The larger the loan, the more money the lender will be out if you end up defaulting on it.
Length of loan term: The longer the loan term, the bigger the opportunity for something to happen that makes the borrower unable to hold up their end of the deal. So, stretching out the loan repayment term tends to garner higher interest rates to offset that heightened risk.
Borrowing frequency: This factor can go both ways. Someone with a strong history of repaying what they borrow may see their application bolstered, while someone with a history of applying for a lot of credit — particularly in a short amount of time — may see it hurt their chances.
How Borrowers Can Strengthen Their Loan Applications
Knowing lenders will be carefully examining these factors when you apply, you’re probably wondering: What can you do to put your best foot forward and maximize your chances of getting approved?
Start by checking your credit report from each of the three reporting bureaus — TransUnion, Experian and Equifax — and combing through it top to bottom for errors, which you should dispute as soon as you find them.
Tally up the percentage of total credit you’re using on a per-account basis and total. Try to get this below 30 percent before you apply for any additional debt if possible.
Rectify late payments and come up with a system to make your payments on time, as missed payments will hurt your credit score substantially.
Last but certainly not least, try to optimize your income by building up a steady history of income leading up to your application and looking for additional ways to make more money.
Lenders will primarily look at your creditworthiness, income and loan terms when you apply for a loan. Knowing this ahead of time gives you a head start on making your application strong before you turn it in.