When you have a large expense or an unexpected bill that you need to pay, a personal loan can help you fill the gap in your budget. Qualifying for a personal loan isn’t always easy, and getting the best interest rate can require that you meet specific criteria imposed by the lender.
Personal loan requirements differ between lenders but there are a few key components such as credit score, debt-to-income ratio, and payment history which are reviewed by lenders across the board.
Use this guide to help you understand the various personal loan requirements and how to improve your chances of qualifying for a loan.
What is a personal loan?
A personal loan is money that is borrowed from a financial institution such as a bank, credit union, or an online lender. Repayments normally have a fixed interest rate and the total loan amount plus interest is paid back between two to seven years.
You can use a personal loan for a range of purposes such as consolidating debt into one monthly bill, covering emergency expenses, making home repairs and improvements, helping cover moving costs, paying for a wedding or vacation, and paying medical bills.
How much can you borrow for a personal loan and for how long?
A personal loan can allow you to borrow between $1,000 and $100,000 with terms ranging from one year to seven years. If you are applying for a secured personal loan, you may be able to apply for a larger amount, depending on the value of your asset.
You’ll be required to make monthly interest payments; however, some lenders may give you the option to skip a payment interest-free after you have made 12 consecutive on-time payments.
Longer loan terms allow you to spread your payments over a longer period of time, lowering your monthly payments. However, the benefit of lower monthly repayments can be offset by the higher interest charges attached. This is because lenders consider long-term loans as riskier and offset the risk with higher interest rates.
When taking out a personal loan it’s important to consider how much you can afford to borrow considering your current debt and income.
What are personal loan requirements?
When shopping around for a personal loan, it’s important to compare multiple lenders and the eligibility criteria. Some lenders may have minimum income thresholds and other lenders will exclude anyone with bad or limited credit.
Here are a few personal loan requirements that are commonly evaluated by financial institutions:
Credit score and history: Your creditworthiness is an important factor in determining whether you’re eligible for a loan. The higher your credit rating the more options you’ll have when you come to choose a lender. This is because lenders prefer to work with borrowers that are lower risk and have a history of making on-time payments.
Your credit score is made up of various components such as your credit utilization ratio, payment history, and length of credit history that tell a lender how you’re likely to behave when borrowing money.
While there are lenders that will work with borrowers with bad credit or no credit history, the majority will ask for a minimum of good to excellent credit. With a stronger credit history, you’ll be eligible for lower interest rates and better terms and conditions.
Income: Lenders may have a minimum income threshold to ensure that borrowers are able to meet repayment obligations. Some lenders have a minimum income requirement of $45,000 and other lenders do not disclose the amount.
You’ll need to provide proof of income to show that you can afford to pay back your loan and lenders can ask to see your bank statements to evaluate how you are spending your money.
Your income can affect the repayment term that is offered to you. Shorter repayment terms can involve higher monthly payments which can be cheaper in the long run as less interest is charged. However, if the high monthly repayments are unaffordable for your monthly budget, you may be offered a longer repayment term that’ll have lower monthly payments but higher interest charges.
Debt-to-income ratio: Your debt-to-income ratio is the percentage of your monthly debt payments relative to your income. A high debt-to-income ratio can indicate greater financial stress, and you may not be able to afford repayments on your new personal loan.
Applicants with a debt-to-income ratio of 36% or lower are more likely to be eligible for a personal loan.
Collateral: When you apply for a personal loan, you can choose to apply for a secured or unsecured loan. A secured personal loan requires an asset to be used to repay the loan if the borrower defaults.
Types of collateral you can use include, cars, real estate, stocks, bonds, cash in a savings account, jewelry, fine art, boats, collectibles, and antiques.
Loan purpose: Some lenders have specific purposes that you can use for a personal loan. Be mindful to be upfront and honest in your loan application.
What documentation do you need to apply for a personal loan?
Personal loan applications require documentation to support your loan application. Documents can vary depending on your lender but most lenders require the following to start the process:
- Loan application: Each lender will have its unique loan application and some lenders will allow you to submit your application online, while your local bank or credit union may require you to visit a branch in-person. Your application will require basic information such as your name, address, the purpose for the loan, employer information, social security number, date of birth, income, rent or mortgage payments, and phone number.
- Proof of ID: Lenders can require two forms of ID and in most cases, they must be government-issued. Some of these can include your passport, driver’s license, birth certificate, military ID, and state-issued ID.
- Proof of address: To show a lender that you have a stable living situation, some documents you can provide your lender as proof of address include your utility bill, mortgage statement, bank or credit card statement, rental agreement, and voter registration card.
- Income verification: There are various pay documents that you can provide as proof of income. Some of these include tax returns, pay stubs, bank statements, W-2s, and 1099s.
How do you qualify for a personal loan?
Before you fill out your application and send it off for approval, here are a few simple steps you can take to help you qualify for a personal loan.
- Check your credit report: Your credit score is an important factor in determining whether you’re going to get approved or denied for a personal loan. Before you send your application, review your credit report and correct any errors or mistakes. This could have a negative impact on the personal loan application.
In addition, take any action on improving your credit score before you submit your application. Making payments on time for existing debt and reducing your debt-to-income ratio can improve your chances of approval.
- Compare rates for multiple lenders: Many lenders allow you to prequalify for a personal loan which can be done without performing a hard credit check. While prequalification does not guarantee approval, it can give you added confidence when submitting your loan application.
- Apply for your loan: Once you’ve decided on how much you want to borrow and chosen a lender after prequalification, you can submit a formal loan application with the required documentation.
Be mindful to read the terms and conditions so that you are aware of any fees and penalties that could be added to your loan.
What if a personal loan application is not approved?
If a personal loan application is rejected, there could be many reasons and lenders will provide a letter of explanation to give you their justification. Read through the letter and it’s a good idea to take action where you can on the points mentioned.
For instance, if the lender advises that your debt-to-income ratio is too high, you can pay off some or all of your debt, or increase your income to reduce the ratio. This will have a positive impact on your credit score which can improve your chances of approval for a future loan.
Other options you could consider include adding a cosigner to your loan application. A cosigner with a high credit score can improve your chances of approval as it adds a second borrower to your loan. A personal loan application with a cosigner is likely to require additional documentation that provides proof of the cosigner’s income and personal details.
Alternatively, you could apply for a secured personal loan where you can back the loan with collateral such as your car or home. This can be a good option if you’re looking to apply for a larger loan amount, as it reduces the lender’s risk of not getting repaid, increasing your chances of approval. Secured personal loan applications can require additional documentation to prove that you own the asset and verify its value.
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