The personal loan application process can be nerve-wracking. There are many factors and variables that a lender considers before making an approval decision. However, there are times when the lender may decide to reject a loan application, as well. While that can be highly discouraging or disheartening, it doesn’t necessarily mean that it’s the end of the road for your personal loan ambitions.
In this article, we go over some of the main reasons that banks choose to reject an applicant, and some of the proactive actions you can take to avoid this fate.
Table of Contents
- Why Will Banks Reject Loans?
- Personal Loans: Alternatives to Banks
- How to Improve Your Chances of Acceptance
- Final Thoughts
Why Will Banks Reject Loans?
Chartered banks (such as the Big Six in Canada) have strict regulations that must be followed, which are set by provincial or federal authorities. For this reason, banks conduct stringent evaluations of loan applications prior to issuing a loan to a borrower. Some of the most common reasons why they may choose to not issue a loan are as follows:
Low credit score or insufficient credit history
One of the main documents that the bank will utilize to assess your creditworthiness is the credit report. This report has your credit score, history of debt repayments, current outstanding debts, and other relevant information. If your credit score is below the 650 mark (or thereabouts) or if you do not have a sufficient amount of credit history (such as when you are new to the country), a bank may reject the loan application.
Insufficient or unstable income
In the absence of any collateral, the main way for a bank to assess your capacity to repay a loan is your income. If you are unable to demonstrate a regular stream of income from a job or your business, that represents a risk that the bank may not be willing to take. Additionally, if your income is perceived to be too low compared to the size of the loan you are requesting, your application may also be rejected.
High debt to income
The debt-to-income ratio is a calculation used by banks to determine the amount of debt as a percentage of total income. This ratio effectively illustrates how much more debt you can reasonably take on with your current income before you will likely become overburdened. If you are at or near the top end of their target debt-to-income ratio, the bank may choose to reject the loan application.
Inaccurate or missing personal details
When banks request information, it is in your best interest as a borrower to provide that information as quickly and accurately as possible. A missing document, file, or other such piece of information can be the difference between an approved or a rejected application. Luckily, this is one of the easier fixes to make. If you have been rejected for this reason, make sure to be prepared with everything you need prior to approaching the bank again.
Inaccuracies on the credit report
Credit reports are prepared by two main agencies in Canada: Equifax and TransUnion. At times, there may be errors on a credit report due to something like a similar name. Check your credit report with a fine tooth comb to ensure that all information is factual, updated, and reflects your own personal finance situation.
Personal Loans: Alternatives to Banks
While banks are one of the most common sources of personal loans, there are other alternatives that you have as a borrower if the banks are no longer an option. Some of these are listed below:
Online lenders are private lenders that operate without a physical retail branch. These private lenders are often not subject to the same degree of regulatory scrutiny as chartered banks, meaning borrowers can gain much more flexibility in their personal loan agreements compared to the banks. At the same time, it is important to be cognizant and to do your research to find a trusted lender and avoid predatory lending practices.
Credit unions are member-owned institutions that are often structured as non-profits. Built for the purpose of benefitting their members, credit unions can offer favourable interest rates compared to banks or other flexible terms.
Online peer-to-peer lending platforms facilitate connections between borrowers looking for cash and lenders looking to earn a return on their excess capital. However, these lenders are not institutions. They are other people, which means that they are also not subject to the same types of regulations as larger chartered banks, and can offer customized terms based on your needs.
How to Improve Your Chances of Acceptance
There are several steps that you can proactively take prior to approaching a bank for a personal loan.
Build up or repair your credit score
If your credit score is hovering around the 650 mark or below, it is worth investing the time and effort to bring it into the 700s or above, as this is generally considered to be a ‘safe’ threshold for banks. If that is not feasible in the near term, there are several options to help you get the capital you need right now while enabling you to build back your credit score over time through regular repayments.
Budget the monthly loan payment you would be making
Use an online personal loan calculator to enter the variables that you would get on your personal loan. The calculator will then output a number which is the periodic repayment (principal + interest) that you would have to make. Check your bank statement to determine your other monthly expenses and assess whether this additional amount would be feasible given your existing situation.
Have all documentation ready
The most common documents that banks will need are pieces of ID (passport or driver’s license), proof of address (utility bills), and proof of income (such as T4s and pay stubs). Keep these handy and ready to submit at a moment’s notice. It may also be worth it to pull up your own credit report and verify all information to ensure that it is error-free before the bank pulls it on your behalf to assess your creditworthiness.
Prioritize paying back missed/late payments and high-interest debt
Missed or late payments show up on your credit report prominently, and can reduce your score over time. Prioritize paying these back, as well as high-interest debt such as credit cards, before approaching a bank for a personal loan.
Getting rejected for a personal loan can be crushing. However, you can prevent this by avoiding certain pitfalls. If you are looking for a non-bank alternative lender that can offer the flexibility you need while helping you repair your credit over time, contact our team at Magical Credit today!