So, you’ve applied for a loan, and unfortunately, things didn’t go as planned.
Well, you’re not alone.
In June 2023, the overall rejection rate for credit applicants increased to nearly 22% — its highest point since June 2018 — according to a report by the Federal Reserve Bank of New York.
The increase affected people in different age groups and was highest among people with credit scores below 680, the report found.
So what happens when you get rejected for a loan? We’ll explain what it takes to get a loan, why lenders might slam the door on your application and most importantly, how you can improve your odds and even snag a loan with bad credit.
Requirements for a Loan
You’re eager to get a loan, but do you know what lenders look for? Let’s start with the basics.
Whether you’re looking to a buy a house or get a personal loan, you typically need to meet these requirements:
- Good credit score: Lenders use your credit score to assess your risk as a borrower. A good credit score usually falls in the 670 to 739 range. The higher your score, the better your chances of approval.
- Steady income: Lenders need to see that you have a stable income to repay the loan, such as a regular job or self-employment income.
- Low debt-to-income ratio: This is the proportion of your monthly debt payments compared to your monthly income. A lower debt-to-income ratio signals better financial health. Lenders usually look for a DTI of 40% or less.
- Positive credit history: A solid credit history shows lenders you’ve managed credit accounts responsibly in the past.
- Collateral: With a secured loan, an asset (like a car or home) acts as collateral to help offset the risk. This can be an option if you have bad credit or want a lower interest rate.
6 Reasons Why You Might Get Denied for a Loan
Getting rejected for a loan can be disappointing, but understanding the reason behind it can help you make positive changes moving forward.
Bad credit, unstable income and high debt-to-income ratios are a few of the main reasons personal loans get denied.
- Low credit score: Your credit score plays a significant role in the loan approval process. A lower score (think under 650) indicates higher risk to the lender, making them less likely to approve your application.
- Red flags on your credit report: If you’re young or have a limited credit history, lenders might not have enough data to assess your creditworthiness. Certain items on your credit report — such as bankruptcies, foreclosures, collections accounts and missed payments — can remain on your report for several years and may get you denied.
- High debt-to-income ratio: If your monthly debt payments gobble up a big chunk of your income, lenders may doubt your ability to handle additional debt responsibly.
- Unstable employment: Frequent job changes or extended periods of unemployment might make lenders nervous about your ability to repay the loan.
- Too many credit applications: Applying for multiple loans or credit cards within a short time raises red flags for lenders and may lower your credit score.
- Insufficient income: If your income is below the lender’s minimum requirement, they might not believe you can afford the loan.
What to Do If You Get Denied for a Loan
The first thing you should do after getting denied for a loan is to find out why.
If your loan application is denied, the lender will send you what’s called an adverse action letter that explains why, according to Experian, one of the three credit reporting agencies.
Even if your lender fails to send this letter, give them a call and ask. Under the Equal Credit Opportunity Act, you have 60 days to ask your lender why it rejected your application, and they must give you a specific reason for your denial.
Once you have that information, you can start to tackle that financial roadblock.
Here are a few ways to help improve your chances of getting approved for a loan the next time.
- Check your credit report and improve your credit score: Start by obtaining your free credit report from the major credit bureaus (Equifax, Experian and TransUnion) to make sure everything is accurate. Dispute any errors you find. To build a good credit score, pay bills on time, keep credit card balances low and avoid opening new credit accounts for a while.
- Reduce debt: Paying down existing debts can significantly improve your debt-to-income ratio. Consider using any extra funds, such as your yearly tax refund or a bonus at work, to tackle outstanding balances.
- Build a credit history: If you’re new to credit, consider applying for a secured credit card or becoming an authorized user on someone else’s credit card. Responsible use will help establish a positive credit history.
- Space out loan applications: Applying for a loan results in a hard inquiry on your credit report, which can lower your credit score. Space out your applications and focus on finding the right loan match.
- Consider a cosigner: If your credit score is still not where you want it to be, a cosigner with good credit can increase your chances of approval. Just be sure both parties understand the risks involved.
How to Get a Loan if You Have Bad Credit
Getting rejected for a loan can be disheartening, but don’t let it get you down.
Use this setback as an opportunity to improve your financial standing. Take steps to boost your credit score, manage debt responsibly and explore alternative lenders if needed. Remember, it’s all about progress, not perfection.
Having bad credit doesn’t mean you’re out of the game, either. There are still ways to secure a loan, though it might come with a higher interest rate or less favorable terms.
Here are some options:
- Online lenders: Some online lenders specialize in providing loans to people with bad credit. They might consider other factors beyond credit scores.
- Credit unions: These not-for-profit financial organizations are more community-oriented and might be more willing to work with members with less-than-perfect credit (think 629 or lower). You’ll need to become a member of the credit union before applying.
- Secured loans: Offering collateral for a personal loan or seeking a loan with built-in collateral for a house or car can make lenders more willing to approve your loan application. Just remember that a lender can seize your collateral if you don’t repay your loan.
- Credit-builder loans: Some financial institutions offer credit-builder loans designed to help people improve their credit scores.
- Joint applications or cosigners: Having someone with better credit vouch for you as a cosigner or joint applicant can bolster your chances.
Frequently Asked Questions
Can You Contest the Decision After Getting Denied?
Yes, you can contest a decision if your loan application is denied. When you receive a loan denial, the lender is required to provide you with a written explanation on why. If you believe the lender made an error or there is incorrect information affecting the decision, you have the right to dispute it.
Can You Reapply After Getting Denied?
Yes, you can reapply for a loan after being denied. However, you should avoid rushing into another application right away. Multiple loan applications in a short period can negatively impact your credit score and may be a red flag to lenders. Instead, take some time to assess the reasons for your rejection and work on improving your creditworthiness.
How Long Should You Wait Before Reapplying?
Generally, it’s wise to wait at least three to six months before reapplying for a loan. This gives you time to make positive changes and increase your chances of approval.
Does Getting Denied for a Loan Hurt Your Credit Score?
Applying for a personal loan involves a hard inquiry on your credit report, and this can cause a slight dip in your credit score. However, the act of being denied for a loan itself does not hurt your credit score. Loan denials are not reported to the credit bureaus and do not have a direct impact on your credit score.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer at Codetic. She focuses on retirement, investing, taxes and life insurance.