Personal loans can be used for almost any purpose. In fact, they are one of the most flexible ways to borrow money, without the high interest rates that credit cards charge. So, what’s stopping people from borrowing money for a yacht and cruising away to the Mediterranean, never to return? Simple: They need to meet the lender’s personal loan requirements.
Personal loan qualifications vary by lender — there is no universal list. However, there are certain red and green flags that lenders commonly look for in a borrower’s credit history. We’ve compiled them here to help you be more prepared before you apply.
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One of the key metrics lenders look at when evaluating an applicant for any loan is credit score. Generally, the higher the credit score, the more likely lenders are to approve a loan and give the borrower a more favorable interest rate. The lower your interest rate, the less money you’ll pay over time. Many lenders consider a score of 670 or above to indicate solid creditworthiness.
If you apply for pre-qualification, many lenders will run a soft credit check (which doesn’t affect your credit score) in order to see if you’re a good candidate for a personal loan. As the process moves forward, and an applicant actually applies for a personal loan, lenders will usually do a hard credit check (that is, a deep dive into your credit history). A hard credit check may knock five to 10 points off your credit score, and can continue to impact your score for a few months.
Most lenders review your credit history as well as your credit score, plus other financial factors like your income, to create a holistic view of your financial situation.
There are two types of personal loans, collateralized and uncollateralized. Collateral is something of value that is used as security for repayment of a loan. In the event of default, the bank or lender may be able to seize the property from the borrower.
When a loan requires collateral, it’s referred to as a “secured loan.” When it does not, it is called an “unsecured loan.” From a lender’s perspective, unsecured personal loans are riskier. Therefore, the requirements for secured and unsecured loans are typically different.
Typically, when people talk about personal loans, they’re referring to unsecured personal loans. Because these loans aren’t backed by collateral, they may have higher interest rates or be harder to qualify for than secured personal loans. Some lenders and banks require collateral for personal loans. Anything from cars to property can be used as collateral, and can be seized in the event that you fail to make your loan payments.
It’s a tradeoff that’s worth weighing before you apply for a loan. If you put your property on the line, you could lose it. But taking that risk may qualify you for a lower interest rate. On the flip side, offering up collateral can come with hidden costs. For example, some lenders may require you to have additional insurance in the event the collateralized property is damaged.
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Proof of Income and Employment
Most lenders will want to be sure that you are gainfully employed and have sufficient income to repay the loan. Proof of income and employment can be required by many lenders to verify how you will repay the loan. This is one way they can ascertain the likelihood that you’ll pay it back. Plus it can affect things like the interest rate or payback term you’re offered.
Like most personal loan requirements, “proof of income” can mean different things for different lenders. Some lenders require a signed letter from your employer, while others need pay stubs or W2s. If you are self-employed and want a personal loan, you might need to submit a copy of your tax returns or provide bank deposit information.
Another important personal loan qualification is debt-to-income ratio (DTI). DTI compares your gross monthly income to the monthly payments you make on your debt. Generally, the lower your DTI, the more desirable you are as a borrower for any lender.
For example, someone earning $120,000 per year might seem like they’re doing great. That’s $10,000 in gross income per month. But let’s say they’re actually having a tough time making ends meet because they’re paying $6,000 per month toward their credit card and student loan debt. Their DTI is 60%, which is considered high — and might make them less desirable to lenders.
Conversely, someone with a lower income, say $60,000 per year, might get better terms on their personal loan offer if they are only paying $500 a month toward student loans. In this scenario, they are earning $5,000 per month and paying $500 per month toward debt, which makes their DTI 10%.
The lower your DTI, the more desirable you usually are as a borrower for any lender.
This one is a personal loan requirement rather than a qualification. Some lenders charge a one-time “origination fee,” which is intended to cover the cost of processing the loan. Origination fees vary by lender and the borrower’s financial situation. Some lenders charge a flat fee for personal loans, while others charge a percentage of the total loan amount. These fees usually range from 1% to 5%, but they can go as high as 10%.
This can be a considerable sum of money, depending on the loan size. Note that you can typically roll this cost into your loan’s total or pay it out of your loan’s principal.
Applying for a Personal Loan
Personal loans are increasingly popular, in part because of their flexibility. You can pay for almost any big purchase with a personal loan. Common uses for personal loans include wedding expenses, emergency home repairs, credit card consolidation, medical bills, and moving costs.
Often it’s better to save for a big expense, even if it takes a few months or years. However, if that’s not possible, a personal loan can be a better option than charging the expense to a credit card. In brief, here are the steps to follow when applying for a personal loan:
1. Figure out how much you’d like to borrow. A personal loan calculator can help you decide.
2. Check your credit. (More on that below.)
3. Get pre-qualified with multiple lenders. This will show you the loan amount you’ll qualify for with each lender, as well as the interest rate and loan repayment timeframe.
4. Choose a lender.
5. Submit your application. This is when you’ll need your financial documents, such as paystubs, tax returns, and bank statements.
How To Qualify for a Personal Loan
Savvy consumers know that they may have work to do before applying for a personal loan. Some tasks are relatively quick, like pulling together financial documents. Other things take more time, like practicing good financial habits over the long term so that your credit score is at its best. Once you have your financial ducks in a row, you can feel more confident that you’ll get your personal loan approved.
Below are a few things to keep in mind if you’re considering applying for a personal loan.
Maintain a Stable Income
Lenders typically prefer a borrower with a stable income. If you plan to apply for a personal loan, it may not be the time to change careers.
If there are other ways to boost your income in the meantime, it may help your chances of qualifying and getting favorable loan terms. Whether that means asking for a raise or picking up part-time work, increasing your cash inflow can make you a more desirable borrower in the eyes of a lender — although not all income is considered eligible.
Get a Cosigner or Co-borrower
A cosigner is someone who agrees to pay the loan if you default. A personal loan co-borrower is someone who may reside with you and takes the loan out with you — their name is on the loan, and you both have an obligation to repay it. Either may improve your chances of qualifying for a personal loan, as lenders view both as an extra layer of repayment security.
Before deciding to bring someone else into the equation, check with your lender if a cosigner or co-borrower is allowed. Then carefully consider the drawbacks. For instance, a cosigner might see a decrease in their credit score if you fail to make a payment. And a co-borrower would have to pay the loan themselves if you default.
Monitor Your Credit Score
If your credit history is less than ideal, you may want to monitor your credit score to learn what actions (or inaction) might hurt it. You can request your credit report for free from each of the three major credit reporting agencies — Equifax, Experian, and TransUnion — at AnnualCreditReport.com.
Check your credit history for errors, such as fraud, misreporting, or a card accidentally opened in your name. Then file a dispute online asking the credit bureaus to remove the errors.
Do your best to pay every bill on time. And try to reduce how much debt you’re carrying relative to your credit limits. For instance, pay down outstanding debt as much as you can. It may also help to pay your credit card bill in full each month.
How To Get a Personal Loan
Personal loans are available from banks, credit unions, and online lenders. If you like to do business with a particular bank, you might start your inquiries there. Existing customers may get better interest rates or receive their funds sooner.
You can also shop around online to check going rates and terms. With online lenders, it’s easy to compare offers. Plus the entire application process is digital.
Qualifications for a personal loan typically include a credit score of 670 or more, proof of income, and a debt-to-income ratio below 30%. Some lenders require collateral to secure your loan; if you default, the lender can seize your property. Lenders may also charge an origination fee of 1% to 5%. Before you apply for a personal loan, maintain a stable income, monitor your credit score, and get a cosigner with excellent credit if necessary. The application process is usually straightforward if you have our financial documentation ready.
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What can be used as collateral for a personal loan?
Just about any assets you own can be used for collateral on a personal loan. That includes your home, car, savings account, investments, and jewelry or collectibles.
How do I know if I will qualify for a loan?
To “preview” the loan terms you qualify for, you can get pre-qualified online for a personal loan. You’ll see the loan amount you’re approved for, plus your interest rate, any fees, and repayment term. Pre-qualification requires a soft credit check only, which won’t hurt your credit score.
Can you get a personal loan without income proof?
Yes, it is possible to get a personal loan without income proof. However, it will be more difficult to qualify, since your credit score and history will have to be exemplary enough to compensate for the lack of income proof. Also, keep in mind that a stable income is more important to lenders than a high salary. If you have a modest income and excellent credit, you can still qualify for favorable loan terms.
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