How Banks Evaluate Personal Loan Applications

personal loan

Personal loans can be a great arrow in your financial quiver for consolidating higher interest rate debts, like credit cards or short-term loans, or financing a major purchase or unexpected bill. With predictability built in, personal loans make it easy to budget for repayment for the life of the loan, and for the most qualified borrowers, repayment can extend up to several years. However, not everyone is eligible for a personal loan through banks or online lenders. Because personal loans do not require collateral – an asset, like a vehicle, a home, or a bank account the lender can use to recoup losses due to default – the application process can be stringent. Here are the most common factors banks review when evaluating a personal loan application.

Credit Score

credit-score

The first place lenders look when receiving a new personal loan application is the borrower’s credit history and score. Credit information is like a financial fingerprint in that it provides a clear picture of who a borrower is in terms of money management and timely debt payment over an entire lifetime. When credit history is clean, and a credit score is above 700, banks are more apt to offer a personal loan with the lowest possible interest rate and budget-friendly repayment term. If credit score and history are on shaky ground due to past late payment, a recent bankruptcy, or a foreclosure, lenders either decline a loan application or charge far higher interest rates to protect their potential for loss.

Employment History

employment

Some banks ask for employment history on a personal loan application, in an effort to understand a borrower’s track record of earnings. When someone has had significant gaps in jobs over the last few years or has had several different employers in a short period of time, lenders may view the borrower as higher risk. Steady employment and increased income over time is what banks are typically looking for to qualify a borrower for a personal loan.

Current Income

IncomeAbove and beyond a borrower’s past financial record, banks want to understand current income. Borrowers with steady earnings from a conventional job are perceived as a lower risk to most lenders, while those who are paid by commission or a bonus structure are less reliable in theory. Banks also want to understand the reliability of the income stream a borrower has, and how that stacks up against other outstanding debts that require a monthly payment. Even when income is steady, borrowers who have several other monthly payments due may not be a strong fit for a personal loan through a bank.

Amount and Purpose of the Loan

The last common factor in reviewing a personal loan application is two-fold: the intent of the borrow and the amount funded. First, personal loans may have some restrictions on what items or expenses they can be used to pay, typically excluding paying off another loan or financing education-related costs. The most common uses for personal loans that are deemed suitable by a bank include debt consolidation, a large expense like a family vacation or holiday spending, or business financing. Second, banks always review the amount of the loan requested and compare that to the borrower’s income and other monthly obligations. For most personal loan applications, no more than $35,000 can be borrowed at one time.

Using a personal loan to manage your finances can be a smart way to leverage your borrowing ability, but take note that banks are going to review your loan application carefully. Before applying for a personal loan, make sure to have documentation relating to your income, a list of previous employers, and a clean credit history to improve your chances for approval.