In 2018, the amount of money borrowed through personal loans reached a record high of $138 billion, which marked a 17 percent rise since the previous year. With these financing options becoming more and more popular, it has become even more important for us to understand the dynamics of this business and how lenders operate.
One important element of this dynamic is the factors that lenders take into consideration before approving or rejecting a loan application. While we will be discussing these factors, it is also just as important to discuss the factors that borrowers should consider before they apply for a personal loan or any loan for that matter.
Today, we will be discussing factors that consumers should consider before applying for a loan and factors that lenders consider when reviewing a loan application. Hopefully, by the end of this article, we will have given you the necessary information needed in order to make a calculated and low-risk decision.
FACTORS FOR CONSUMERS
WHAT LOAN IS RIGHT FOR ME?
First and foremost, you need to be aware of the different financing options available in the market and then judge what type of loan fits your needs.
Different types of loans have different requirements and formalities, some of which are vital in order for the loan to be approved. For example, when people apply for a short-term personal loan, lenders will mostly only ask for collateral to be deposited with a third-party or an escrow account.
On the other hand, if you were applying for a business loan, you need to submit documentary evidence, such as bank statements, undertakings, and no-objection certificates, along with the requirement of placing security or collateral against the loan. It’ll take a little bit of research, but you should be able to find all this information with relative ease by using Google.
Your interest rate makes a direct impact on how much money you will have to pay back.
A simplified formula for how much you need to pay back is the amount of money borrowed plus the percentage (interest rate) of the borrowed amount. Therefore, the higher your interest rate, the more money you’ll be paying back, which is why it’s important to compare interest rates among different lenders to find the best deal.
HOW LONG IS THE PAYMENT TERM
This factor can work both ways when you are deciding on borrowing money. EMIs, or Equated Monthly Installments, are the amount of money you will be paying on a monthly basis until the entire loan amount (added with the interest) is paid in full. Short term loans will have a low-interest rate but a high EMI, whereas long term loans usually have a higher interest rate and smaller EMIs.
Many prefer not to have a long term payment plan, even if the EMI is high, whereas others would choose to go with a long term payment plan provided the EMI is lower as well. In order to conclusively judge how this factor will affect your borrowing and repayment, you will need to check what types of loans are available with a specific lender and what interest rates are being offered.
CAN I AFFORD THE MONTHLY INSTALLMENT
Before you apply for a loan, you’ll be discussing your options with different banks and lenders.
Make sure to get exact quotations on the EMI from your lender so you can judge whether you can make the requisite monthly installment and adjust it in your monthly budget. Missing payments will result in a late payment fine and could adversely impact your credit rating as well. So make sure you are able to make your payments before applying for your loan.
CHECK FOR HIDDEN CHARGES
Many lenders claim to have no hidden charges, but when you add all your EMIs, you’ll see it goes beyond just the borrowed amount and applicable interest rate. This is due to several hidden charges which aren’t really disclosed prior to the paperwork being signed. It is vital that you discuss such charges with lenders. Although, when doing so we advise you refer to these charges as “additional charges” rather than “hidden” as the same would imply something nefarious. Make sure to get everything from your lender in writing.
Depending on the type of loan you are applying for, a down payment may be required. When applying for a mortgage or car loan, you will most definitely have to pay some form of down payment, whereas when it comes to easy loans, a down payment will not be a requirement. Some lenders will offer full financing but it will often be against a higher interest rate. Make sure to check with your lenders on the different financing options available.
A bad credit rating will almost certainly result in a higher interest rate. This is especially true for short term loans. In the event you have a bad credit rating, then work on bringing your credit rating to a more acceptable level before applying for a loan. Your tax consultant should be able to advise you on the best way to do this.
SECURED LOAN vs UNSECURED LOAN
Secured loans involve lending an amount of money against some form of security or collateral being deposited with the bank. Unsecured loans are where full financing is offered without any security or collateral and are usually given at a higher interest rate. Both have different impacts on the EMI, payment terms, and credit requirements, and either can only be judged as being better or worse depending on individual circumstances. You will need to speak to lenders to see which option is best for you based on affordability and accessibility.
SHOULD I CONSULT WITH A BROKER?
Loan brokers can be a huge convenience as they can help you find the best borrowing options from a wide range of lenders. However, it is important that you use a reputable broker as there are a number of scam artists in the market today. It would be best to use a broker through the reference of a friend or family member or, alternatively, do your research thoroughly before going to any broker.
FACTORS FOR LENDERS
As discussed above, credit rating makes a difference in the interest rates that are offered and a very bad credit score can even lead to an outright rejected application. Lenders prefer applicants that have a good credit history as it is an indication as to the person’s ability to repay the loan.
As a reference point, you should know that a score of 800 is considered to be the best credit score and a credit score between 700 and 800 is considered to be very good. Anything below 700 is considered as problematic, whereas if your credit rating goes below 300, then your loan application is most definitely going to be rejected.
This is why it is important that you maintain a healthy credit rating before applying for a loan. If you do not have a good credit rating, then work on improving it before you apply.
Another factor that lenders look at is age. Just as it is with insurance, a younger applicant will be more favored as the risk of death is significantly reduced. While not as strict as insurance agents, lenders do prefer applicants that are within the 30 to 50-year age limit. People falling under this umbrella have a longer time period in which they can hold a professional job and be able to repay the loan. By contrast, someone who is retired and on a pension will not be as likely to be able to repay the debt.
Lenders will have preconceived notions and preferences towards people belonging to specific occupations. This is a key factor especially when lenders consider applications for home loans. The most favored occupations are government-related as they offer the most job security. After government workers, preference is given to doctors and individuals working for blue-chip companies. Then come lawyers, engineers, and chartered accountants.
Finally, the least preferred tier consists of individuals working for private companies and/or are self-employed. All of these different professions have been gauged to have a certain repayment potential and therefore some are preferred over others. While a person’s occupation will not necessarily bar them from acquiring a loan, it may have an impact on the interest rates or repayment terms that the lender will offer.
Lenders look at work experience for an indication of a person’s reliability and stability. If you keep switching jobs, your lender may take it as a sign of you being a flaky person and not sticking with your commitments. The longer your work experience, the more points you score with your lender. If you show you’ve stayed with certain jobs for long and respectable periods of time, then it’s even better.
As a rule of thumb, you should be with one employer for at least three years before moving over to another job. However, this advice is only relevant to loan applications and should not be taken as career advice.
While a loan in your name will be your own liability, lenders to favor applicants who are married and their spouse is engaged in full-time work. In the eyes of the lender, this makes your repayment capacity much stronger as there are two incomes in the household, meaning the family will be able to bear the burden of repayments more easily. However, lenders usually take this factor into account only when it comes to home loans and mortgages.
The amount left over after you’ve paid your EMI is referred to as surplus income. If you’re able to show that you have a high surplus income left after you’ve made your EMI payment, then lenders will favor you more. In the eyes of the lender, having less surplus income increases the risk of you defaulting on your EMI and, therefore, are much more reluctant to lend you money.
REASONS FOR THE LOAN
The simpler the reason is for your loan, the higher the chances of success. If you’re applying for a loan to buy a fully constructed house, then your lender would be much more inclined to grant the loan, whereas the chances go down significantly if the loan is to buy a plot of land and then construct on it. Similarly, if you’re getting a loan to buy a brand new car the chances of success are higher when compared to buying a 10-year old used car.
Just like consumers should take this factor into account, lenders also look at this factor when approving or rejecting a loan application. Lenders prefer short term loans more as they are bound to get their money back in a shorter period of time. The easiest loans to secure are in the 5-year range, whereas it gets more and more difficult the longer the repayment term is.
This is one of the reasons there are so many formalities and requirements when it comes to getting mortgages, as they tend to be in the 30-year range. Therefore, the shorter the repayment period is, the higher the chances are of success on your loan application.
PRIOR EXISTING RELATIONSHIP WITH THE BANK
This factor is limited to banks only, but if you have a prior existing relationship with your bank, the chances of success on a loan application are significantly higher. If you’ve held an account with a specific bank, they are aware of your financial history and will be in a great position to judge whether you are able to make your payments in a timely manner.
There’s also the added benefit of having a pre-existing dialogue with the bank. As the personnel there would know you already, your communication with them will be a lot more relaxed.
The familiarity might work in your favor as, because of that prior existing relationship, you could even be offered special deals and considerations on your application.