In today’s rough environment, knowing how to build credit isn’t enough if you want to also know how to qualify for a loan.
Ideally, a loan sits on a stool with four legs: income, down payment, savings, and credit score. If necessary, a stool can stand with just three legs. It cannot however, stand on just two, and it is important for would-be borrowers to understand this when learning how to qualify for a loan.
You are going to need at least three out of four “stool legs” to get a worthwhile loan.
Before applying for a loan, understand that the lender is in the business of earning a return on its investment. The lender could invest in the stock market, bonds, annuities, mutual funds, or any number of other things. The lender is only interested in giving you a loan to you if the lender can earn a worthwhile return in the form of the interest payments you make as the loan is paid.
To make this determination, the lender considers the four stool legs we discussed.
How to Qualify for a Loan—Stool Leg Number #1: INCOME
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.
How to Qualify for a Loan—Stool Leg Number #2: DOWN PAYMENT
Next, the lender considers the down payment you are going to make on a loan attached to property (such as a car or home loan). The bigger the down payment, the more protection a creditor has. First, the property has more equity invested in it, meaning it is more likely to have enough equity to be sold at a profit to pay off the loan. As well, the borrower has more invested in the property and is therefore more likely to prioritize loan payments.
How to Qualify for a Loan—Stool Leg Number #3: SAVINGS
The lender considers your savings. Also called “reserves,” your savings are important because they tell the lender your likelihood of weathering any rough spots in your life, getting back on your feet, and making those loan payments.
How to Qualify for a Loan—Stool Leg Number #4: CREDIT SCORE
Finally, the lender considers your credit score. The credit score gives the lender a glimpse into your character and how important it is to you to keep your word and repay your debts. It also further assists the creditor in analyzing your ability to repay by revealing whether you are already carrying large amounts of debt.
When considering how to qualify for a loan in today’s market, a person really needs four out of four stool legs, though some exceptions might apply. If the would-be borrower is strong on any three out of the four, a lender might make an exception, even if his 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 would pay high interest rates.
For major purchases, like cars and houses, it’s worth thinking about these four criteria at least six months to a year in advance of 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.)
Get a copy of your FICO Score and review it for any errors. If you find them, contact the credit bureaus and follow their steps to have the information corrected. Make all you payments on time, and try to pay down your balances on existing accounts. Attend our free teleseminar so that you can learn how to improve your credit score quickly.
Although the four legs of our stool are the most important criteria, learning how to qualify for a loan means that you take a look at some smaller factors as well. How long have you been at your current job and address?
- People who move around a lot are generally consider 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.
In today’s market, knowing how to qualify for a loan can be tough. Lenders have more stringent guidelines than ever before. Remember to start early and learn everything you can about building picture-perfect credit!