Building credit and qualifying for a loan is simple, if you know how to do it. For those who don’t know how to build credit or qualify for a loan, here are four easy steps to follow.
Imagine a loan as a stool with four legs: income, down payment, savings, and credit score. A four-legged stool is dependable and safe. However, a stool can also have three legs and be just as sturdy. But a two-legged stool doesn’t work. It cannot withstand pressure. A four-legged stool is best because it incorporates all the requirements for a loan. But a three-legged stool is also acceptable when qualifying for a loan.
Borrowers must know why a lender is willing to lend them money. It is not because the lender is generous but because the lender is in the business of earning a return on its investment. The lender may want to invest in the stock market, bonds, annuities, mutual funds, or any number of other things. If you can help the lender accomplish its goals then you will receive a loan. The bottom line for a lender is always earning a worthwhile return in the form of the interest payments on loans.
To determine if you’re a good candidate for a loan, the lender evaluates each leg of a stool.
The lender considers your income. The higher your income as compared to your existing debts (your “debt-to-income ratio”), the more likely you are to make your monthly payments.
After evaluating your income, the lender looks at your down payment for the loan. Your down payment for a home loan is probably greater than your down payment for a car simply because of the value attached to both. As with everything, bigger is always viewed as better. The bigger the down payment, the more protection a creditor has.
A bigger down payment on property is better for the lender because the property will have more equity invested in it. This means a property will have enough equity to sell at a profit to pay off the loan which is good for the lender. It is also good for the borrower because the borrower has more invested in the property and will be more likely to make loan payments on time.
Savings are important to a lender because savings are your reserves during difficult times. The amount of your savings or reserves allows the lender to have security if you experience a rough patch. With sufficient savings, the lender feels you are more likely to weather rough spots while making loan payments. The lender looks for security and your savings give that security
After evaluating your income, down payment, and savings, the final step is to evaluate your credit score. You may wonder why the lender looks at your credit score if it’s satisfied with your income, down payment and savings. Your credit score is important because it gives the lender a glimpse into your character. It lets the lender know if you are a person who keeps your word and repays your debts. Your credit score also helps the lender analyze your ability to repay by revealing your current amount of debt.
Know the importance of each step when applying for a loan. As with a four-legged step stool, all legs being equal, your position is more secure when qualifying for a loan. However, that is not always the case and some exceptions may apply. If the would-be borrower is strong on three of the four legs, a lender might make an exception, even if the fourth leg is weak. A strong income may make up for a lack of reserves. Or a high credit score can make up for a small down payment. In normal lending environments, a borrower with a strong income, lots of savings and a big down payment will probably be allowed to slide on a mediocre credit score, but s/he will pay high interest rates.
It is wise to consider these four facts at least six months to a year before making a major purchase such as a car or a home. This gives you the opportunity to look your best financially when applying for a loan.
Keep your income as high as possible when learning how to qualify for a loan. You can get a second job or work to bring home additional commission. This will help your income, savings, and down payment. Dedicate as much of your monthly earnings to a savings account and maximize your reserves. Learn how to create a budget. If you have family members willing to help you with the down payment, get the money from them in advance so that when the lender looks back at several months’ worth of bank statements, the lender will see consistent higher balances. (Keep in mind that you should discuss the tax consequences for cash gifts with a tax consultant.)
Know your FICO Score and review your credit report for errors. If there are any errors on your credit report, contact the credit bureaus and follow their steps to have the information corrected. Timely payments on current accounts and low balances on existing account are a plus. You can always join our free teleseminar which tells you how to improve your credit score quickly.
The four facts lenders evaluate are very important when learning how to qualify for a loan, but there are other factors to consider such as: how long have you been at your current job and address?
- People who move frequently are generally considered bigger risks than borrowers with proven job stability and a permanent address. From a lender’s perspective, a stable lifestyle—two or more years at the same address—equals a safe investment.
- In addition, the lender wants to know that you have a history of making plenty of money to afford the loan. Ideally, your job should also be stable, meaning you have been employed for at least two years at the same company.
Be prepared! Know how to qualify for a loan in different financial markets. Do not allow a lender’s stringent guidelines prevent you from achieving your goals. Start now to build picture-perfect credit!