How to qualify for a personal loan

You can use a personal loan for almost any purpose. Here’s how to qualify for one. (iStock)

If you’re facing an unexpected emergency or expense, or you want to consolidate multiple high-interest debts into one lower payment, you might be considering a personal loan. 

Before you’re officially approved for a loan, you can prequalify with several lenders to compare loan offers for the best interest rate, terms, fees, and loan amount. This guide will cover the process of qualifying for a loan from start to finish.

How to qualify for a personal loan

A personal loan is a type of credit that can help you consolidate debts, pay for unexpected expenses, or make a big purchase. You can get a personal loan from a traditional bank, a local credit union or an online lender. And many borrowers turn to online lenders to take out a personal loan because they often have a streamlined application process and quicker loan approvals.

In 2020, 20.9 million consumers had personal loans, with balances totaling $162 billion, according to TransUnion data. If you’re considering a personal loan for your unique financial needs, here are the steps to take to qualify for a loan.

You can compare personal loan rates in minutes using Credible.

Decide how much you really need to borrow

Begin by figuring out how much cash you need. It’s wise to avoid getting loans for more money than you need since you’ll be paying interest on the balance. At the same time, remember that many lenders charge an origination fee, and you’ll need to borrow enough to cover your needs after the fee is deducted from the loan funds.

To help you determine how much you can borrow, use Credible’s Personal Loan Calculator to get an idea of what your monthly payment might be.

Check your credit reports

Since lenders usually review your credit reports as part of their underwriting process, it’s a good idea to check what’s on them. If there’s any inaccurate information, you can dispute it with the three major credit bureaus — Equifax, Experian, and TransUnion — and request they correct the error(s).

You have the right to obtain a free credit report every 12 months from each bureau, which you can request at AnnualCreditReport.com. Right now, the site will give you free credit reports every week through April 2022.

You may qualify for a personal loan with fair credit, but you’ll usually need good or excellent credit to be eligible for a loan with the lowest interest rate. 

Get prequalified

After you’ve reviewed your credit, it’s time to prequalify for personal loans from multiple lenders.

Prequalification is when a lender reviews the information you provide — like your employment status, income, and the amount you wish to borrow — and gives you a tentative loan offer. As part of the process, the lender will usually initiate a soft credit pull, which doesn’t impact your credit score.

Note that prequalification happens while you’re shopping for and comparing loan offers, and the requirements usually aren’t very strict. By contrast, a pre-approval typically requires that you provide more information to the lender, who will likely perform a hard credit pull. This may affect your credit.

Shop around and compare lenders

You’ll want to shop around and receive a handful of prequalified loan offers. Don’t accept the first loan offer you receive since you may receive better terms with other lenders. 

Remember, the offers you receive contain provisional rates and terms, which are subject to change once you formally apply with the lender.

Credible lets you easily compare personal loan rates from multiple lenders in one place.

Go over loan details

As you compare loan offers, pay special attention to the following:

  • APR: Annual percentage rate, or APR, is the total cost of the loan, including the interest rate and any fees.
  • Loan term: Longer-term loans usually come with lower monthly payments. But the longer the loan term, the more interest you’ll pay.
  • Origination fee: Some lenders charge this fee to process your loan application, and it’s usually deducted from your total loan funds.

Apply for the loan

Ready to formally apply for a personal loan? The information you’ll need to provide could vary among lenders. But you’ll typically have to furnish your contact information, income and employment data, recurring monthly expenses, and the purpose for the loan.

After you apply, you may be asked to provide supplemental documents, including …

  • Proof of residence
  • Copy of your driver’s license
  • Bank statements
  • Tax returns
  • W-2s
  • Pay stubs

It’s important to submit any required documentation as soon as possible in order to keep the application process moving along. 

Close the loan

The lender will review your application and supporting documents and decide whether to approve you for the loan. If you’re approved, you’ll need to sign the final loan documents and accept the interest rate and terms. 

Once the loan is finalized, the funds will be transferred to your bank account, which could take a few business days if your lender is a traditional financial institution. If you’re dealing with an online lender, you might receive your funds in as little as one business day, depending on the lender.

What factors do lenders consider when you apply for a loan?

Lenders consider several factors when determining your eligibility for a personal loan.

  • Credit score and history: Having a good credit score makes it easier to qualify for personal loans and other types of credit, with lower interest rates to boot. Lenders determine your credit health by reviewing your credit score and credit reports for negative marks, such as late or missed payments and accounts in default. 
  • Income: Proof of income and a stable employment history signal to lenders that you can manage the personal loan repayment. By contrast, inconsistent income and shaky employment history could cause concern for lenders. 
  • Debt-to-income ratio: Your debt-to-income (DTI) ratio compares the amount of your monthly debts against how much you earn. To determine your DTI ratio, divide your monthly debts by your monthly gross income. A low DTI ratio usually indicates that you can afford the payments on a new personal loan.

Will qualifying for a personal loan hurt my credit?

Applying for a personal loan could hurt your credit score in the short term, but it could help it in the long term. 

When you prequalify with lenders, they may perform a soft credit inquiry as part of a background check. Based on the information they find, they may extend a prequalified loan offer for a specific interest rate and loan term. Soft inquiries aren’t  tied to a credit application, and many creditors perform them so that they can send you prequalified loan offers in their marketing campaigns. As such, soft inquiries have no effect on your credit.

If you agree to a loan offer, final approval will depend on a more formal application, and at that point, the lender will perform a hard credit inquiry. 

A single hard inquiry may lower your credit scores up to five points, and multiple hard inquiries could have a more significant impact on your credit scores. That’s because lenders and scoring models view numerous credit applications in a short time frame as a sign of risk and an indicator that you may be short on cash. 

Hard inquiries fall off your credit reports after roughly two years, and it’s widely believed most scoring models lower or negate their impact well before that.

On the plus side, making consistent monthly payments before the due date could help you establish a positive payment history. Your payment history is the single biggest factor in determining your score, accounting for 35% of your score, according to FICO.

And if you consolidate debts with a lower-interest personal loan, you could pay down your debt faster, improving your credit utilization, which accounts for 30% of your FICO score.

Of course, the opposite is also true. If you default on your loan, the impact on your credit scores could be devastating. And if you run up credit balances after consolidating your debts, your credit utilization ratio will rise, and your credit score might do the same.

See what rate you might qualify for by comparing personal loan rates using Credible.

What to do if you don’t qualify for a personal loan

Unfortunately, not everyone is approved for a personal loan. Among the most common reasons applicants fail to qualify for a loan are poor credit history, high debt-to-income ratio, and inconsistent employment history. If you don’t qualify, the lender must send you an "adverse action notice" that details the denial of your loan application and names the credit bureau that furnished the information.

Here are some steps you can take to improve your chances of qualifying for a personal loan in the future. 

  • Find out why your application was rejected. Review the adverse action notice you receive. It details the reason why you weren’t approved for the loan. Armed with this knowledge, you can work to resolve the issue before applying for credit in the future. 
  • Work to improve your credit score. If your credit score was too low, take steps that may boost your score:  Make your payments on time, lower your DTI and credit utilization ratios, and hold off on applying for more credit to restrict hard inquiries.
  • Boost your income. Lack of sufficient income is another common reason lenders deny personal loan applications. Consider asking your employer for more hours or a pay raise. You may even consider getting a second job or side hustle to increase your monthly income.
  • Apply for a smaller loan amount. Perhaps your income is sufficient for a smaller loan. A smaller loan presents less risk to a lender, and it may improve your DTI enough to help you qualify for the loan.
  • Consider a cosigner. You may qualify for a better loan — with a lower APR and higher loan amount — if you apply with a cosigner who has good or excellent credit. 

Personal loan alternatives

Even though you can use personal loans for practically any purpose, they may not be the best option for you and your unique financial circumstances. If you’re denied a personal loan, or if you’re interested in pursuing a different option, you may find these alternatives are a better fit for you.

  • 0% APR balance transfer credit card: It’s hard to beat 0% interest, especially when you can consolidate multiple high-interest credit accounts into one interest-free payment. Just make sure you pay off the balance in full before the introductory period ends — otherwise you’ll start accruing interest at the card’s regular rate. 
  • Peer-to-peer loan: If a lender denies your personal loan application, consider a loan funded by investors rather than a traditional financial institution.

Borrow from friends or family: 

It may be awkward to ask a close friend or relative for a loan, but if they’re willing to help you out, you should be able to work out a deal that beats anything the traditional banks offer. Just make sure you both agree to a repayment plan before you accept any money so that expectations are clear and you don’t put a strain on the relationship.

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