What Happens if Your Loan Is Denied?

Understanding Why Your Loan Was Denied

If your loan application is denied, the lender will send you what's called an adverse action letter that explains why.

Your credit history and your income are the primary reasons a lender may deny your application, but depending on the situation, there may be other reasons as well. Here are some of the potential factors that could contribute to your denial:

Credit

Your credit history and credit scores are primary factors lenders consider when you submit a loan application. Most negative items remain on your credit reports for seven years, but their effect on your credit typically lessens over time.

If lenders see any significant negative items on your credit report or other red flags, they may determine that, as a borrower, you're too risky to approve at this time. Common credit report items that can affect your score and potentially contribute to a denial include:

• Bankruptcy
• Foreclosure
• Collection accounts
• Delinquent payments
• High credit card balances
• Too many recent credit inquiries
• Not enough credit history

You can also be denied if your credit score is lower than the lender's minimum requirement. To prevent this from happening again, make sure you know your credit scores and shop around for loans that are targeted to your credit range.

Income

If your lender denies your loan application based on income, two issues are the likely culprits. The first is that your income doesn't meet the lender's minimum requirement. Because most lenders don't publish this information, it's hard to know if your income is high enough to meet their standards unless you ask or apply.

The other reason is that your debt-to-income ratio (DTI) is too high. You can calculate this ratio by dividing your total minimum monthly debt payments by your monthly gross income.

Most lenders require a DTI of 50% or less, and mortgage lenders may go as low as 43% or even lower. If yours is too high, lenders could view you as unable to afford an additional loan payment. To improve your chances of getting approved the next time you apply, work on paying down some of your debts—or increasing your income.

Other Reasons for Denial

While your credit and income are the primary factors lenders consider, they don't tell the whole story. As such, you may be denied based on other reasons, such as:

• Employment history
• Residence stability
• Cash flow or liquidity problems
• Too much existing available credit

While you may not have a lot of immediate control over some of these issues, take the reasons seriously and wait until you're in a better position to apply again.

Getting Denied Does Not Hurt Your Credit Score

When you submit a credit application, the lender or creditor will generally run a hard inquiry on one or more credit reports, which will be notated on your reports. For most people, a hard inquiry knocks fewer than five points off their credit score, but that little dip will not last long—12 months at the most.

If you're denied, though, it doesn't have an additional impact beyond the initial inquiry. If you're unsure about whether you'll qualify for a loan and want to avoid a hard inquiry, consider lenders that offer prequalification. This process allows you to gauge your eligibility and even view initial rate quotes with just a soft inquiry, which won't impact your credit scores.

How to Get a Loan When You Have Bad Credit

Whether you need money to finance a large purchase, cover living expenses or consolidate debt, it could still be possible to do so even with bad credit.

Choose a Lender That Specializes in Bad-Credit Loans

Some lenders specialize in working with borrowers with bad credit and have less stringent credit requirements. The catch is that your interest rate will generally be higher than what you'd qualify for with fair, good or excellent credit.

Apply With a Cosigner

Ask a loved one with good credit to apply with you as a cosigner. A cosigner applies for the loan with you and could improve your chances of getting approved. Even if you can get approved on your own, enlisting a cosigner with a great credit history can help you score a lower interest rate.

Keep in mind, though, that cosigners are equally responsible for paying off the debt. So if you default, it could damage both your credit and theirs.

How to Build Your Credit Before Applying for Another Loan

While it's possible to get approved for a loan with less-than-stellar credit, you may be better off waiting until you can improve your credit scores. Doing so could save you on monthly payments and interest charges over the life of the loan.

Review the Adverse Action Letter and Your Credit Report

By law, you're entitled to a free copy of your credit report if a loan application is denied. The lender should provide instructions in your declination letter for requesting a free report from the credit reporting agency that provided the report the lender used to make its decision.

If you don't receive these instructions, you can still request your report directly from the credit reporting agency listed on your declination letter. With Experian, for instance, the Report Access page offers instant access to your report through a secure, encrypted connection.

To improve your credit, focus first on the reasons included in your declination letter. Also, get a copy of your free credit report and check to see if there's anything else you need to address.

Practice Good Credit Habits

Regardless of the reason for your denial, focus on practicing good credit habits to improve your credit over time:

• Make your monthly payments on time: Your payment history is the most important factor in your credit score, and payments that are at least 30 days late show up on your credit report as negative items.
• Keep your credit card balances low: Your credit utilization rate—your total credit card balances divided by their total credit limits—is another important factor in your credit score. If you have high balances, pay them down as quickly as possible, then keep them low going forward.
• Avoid too many hard inquiries: If your loan application was denied, it can be tempting to apply again and again until you get approved. But while each hard inquiry doesn't have a big impact on your credit on its own, multiple in a short period can have a compounding effect on your credit score.

Improving your credit can take time. But if you do it right, you could save hundreds of dollars or more the next time you apply for a loan.

Monitor Your Credit to Track Your Progress

Using Experian's free credit monitoring service, you can track your progress toward a higher credit score and spot potential issues as they arise, so you can address them promptly. The service not only offers free access to your credit score and Experian credit report, but also provides real-time alerts when changes are made to your Experian credit report.