Your credit reports contain a lot of information, but some items are more important than others. Part of the Series Debt Management Guide
What do lenders consider when they look at your credit report? Its a simple question with a complicated answer, because there are no universal standards by which every lender judges potential borrowers. It can depend on both the lender and the type of loan.
Of course, there are some items that will increase or decrease your odds of approval just about everywhere. Looking at what makes up your FICO score (the most widely used credit scoring model) is a good place to start. FICO scores range from 300 and 850, with anything 670 or above considered good or better. If your score is much lower than that, you will probably find it difficult to borrow money at favorable interest rates and maybe at all.
Getting approved for credit can seem like a mysterious process. You fill out application forms submit your information and then wait anxiously to hear back, wondering what exactly the lenders are looking for.
The good news is that it’s not actually magic or rocket science, Creditors look at some standard criteria when deciding whether to approve credit applications Understanding these key factors can help you put your best foot forward and boost your chances of getting the credit you need
In this comprehensive guide, we’ll walk through the main things creditors consider when reviewing credit applications. Read on to learn what creditors want to see and how you can position yourself to look like a trustworthy borrower.
Your Credit History and Credit Score
One of the first things any creditor will look at is your credit report and credit score. This provides a snapshot of how you’ve managed credit in the past.
Lenders want to see that you have a track record of using credit responsibly and making payments on time. Late payments, missed payments, defaults, and bankruptcies will hurt your credit profile. Excellent credit shows creditors you are a low-risk borrower who pays debts reliably.
In addition to your credit report details, most lenders will also look at your credit score, usually your FICO score. This three-digit number summarizes your creditworthiness based on the information in your credit report. Scores generally range from 300 to 850.
- FICO scores above 700 are considered good to excellent credit.
- Scores of 670-699 are fair to good.
- Scores below 580 are considered very poor.
In general, the higher your credit score, the better your chances of approval and lower interest rates. People with excellent credit tend to get the best loan terms.
Your Income and Debt-to-Income Ratio
Creditors want to see that you have enough income to comfortably make monthly payments. When reviewing applications, lenders look at your income amount as well as sources of income. Steady employment and verifiable income are positives.
Lenders also calculate your debt-to-income ratio (DTI). This measures your existing debts compared to your income.
- To calculate DTI, add up your monthly debt payments including housing, loans, credit cards, etc.
- Divide this number by your monthly gross income.
For example, if you pay $1,000 per month towards existing debts and your gross monthly income is $4,000, your DTI is 25% ($1,000/$4,000).
Many lenders prefer a DTI under 36%. A high ratio means you have less income available to cover new loan payments, making you a riskier borrower.
Your Assets and Capital
Lenders look beyond just income. They also want to see assets, savings, investments, or other capital you can tap if needed to make payments. This provides a backup plan if you lose your job or face financial hardship down the line.
Details about assets and capital can carry more weight for large loans like mortgages versus smaller credit card limits. Still, showing substantial assets can help improve your creditworthiness for any type of credit application.
Your Collateral
For secured loans like mortgages, auto loans, and home equity loans, creditors look at the collateral you put up. Collateral is an asset that secures the loan and can be seized if you default.
With a mortgage, for example, the home itself serves as collateral. With an auto loan, the vehicle is collateral. The lender appraises the asset to determine its market value and makes sure it is sufficient to cover the loan amount in a worst-case scenario.
Having substantial equity in the collateral asset (value minus any debts) helps demonstrate you can back up the loan.
The Purpose and Type of Credit
Many lenders want to understand why you need the credit and how you plan to use it. Taking out a loan to cover everyday expenses looks riskier than borrowing to purchase a home, for example.
The type of credit is also important. When applying for a mortgage, lenders want to see experience managing long-term installment loans. Credit cards don’t demonstrate the same financial habits.
Having experience with the same type of credit you’re applying for can make approval more likely.
Your Credit Mix and New Credit
Lenders prefer to see experience managing different types of credit – credit cards, retail accounts, auto loans, mortgages, etc. This demonstrates you can juggle multiple types of accounts responsibly.
At the same time, opening many new accounts too quickly can be a red flag for overspending or financial distress. Creditors typically want to see a healthy mix of credit without a sudden spike in new accounts.
Other Factors
Other items lenders may consider include:
- Your age and employment history
- Where you live – this can indicate stability
- Previous relationships with the lender
- Industry standards and lending regulations
- Current economic conditions
The importance of each factor varies by lender and loan type. But examining these key areas provides a window into how creditors assess borrowers.
Tips for Getting Approved
Now that you know what creditors look for, here are some tips to boost approval odds:
- Check your credit report – Make sure it’s accurate and dispute errors.
- Pay down balances – Lower credit utilization to under 30%.
- Make payments on time – Set up autopay to avoid missed payments.
- Limit new credit – New accounts can be red flags, space them out.
- Build credit mix – Apply for new types of credit sparingly over time.
- Clean up issues – Settle collections, dispute errors to improve history.
- Maintain solid income – Lenders want to see stable earnings.
- Boost savings – Money in the bank reassures creditors.
- Limit inquiries – Too many in a short time can hurt.
The approval process doesn’t have to be a mystery. By understanding what lenders look for and managing your credit proactively, you can put yourself in a strong position when applying. With a thorough credit application reflecting low risk, you’re much more likely to get approved and score the ideal loan terms.
Your Payment History
More than anything else, lenders want to get paid back. Accordingly, a potential borrowers track record of making on-time payments is of particular importance. In fact, in calculating a persons FICO score, payment history is the single most important factor, accounting for 35% of the score. Nobody is excited about lending money to someone who has been lax in repaying their debts.
Late payments, missed payments, mortgage default, and bankruptcy are all red flags to lenders, as is having an account thats been referred to a collection agency for lack of payment. While a few blemishes on your payment history may not stop lenders from extending credit to you, you might be offered a smaller loan or credit line than you would have otherwise qualified for, and you are likely to be charged a higher rate of interest.
Your Credit Mix
From credit cards to car loans and mortgages, there are a variety of ways consumers use credit. From a lenders perspective, variety is good. Lenders like to see that their prospective clients have experience using multiple sources of credit in reliable ways, particularly the kind of credit they are offering. That doesnt mean, however, that you should open a new type of credit account just for the sake of your credit score. As FICO itself says, “Dont worry, its not necessary to have one of each.” FICO score calculations give a 10% weight to the types of credit an individual has.
Most people have more than one FICO score. For example, FICO offers scoring models tailored to mortgage lenders, auto lenders, and credit card issuers. So even if you obtain your credit score, it may not be identical to the one the lender is using.
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FAQ
How will a creditor determine if they offer credit to you?
Lenders will ask for verification of your income and debt payments to ensure you have the capacity to take on a loan. They might require that you submit current pay stubs, past tax returns, or W2s.
What are the 5 C’s of credit analysis?
The 5 Cs of credit are a framework used by lenders to evaluate a borrower’s creditworthiness. They include: Character, Capacity, Capital, Collateral, and Conditions.
What credit do creditors look at?
What credit score do lenders use? FICO scores are generally known to be the most widely used by lenders. While FICO Score 8 is the most common, mortgage lenders might use FICO Score 2, 4 or 5.
What credit score do you need to get a $30,000 loan?