Having a poor credit score can feel like a huge roadblock when you need to borrow money. After all, lenders always check credit reports and scores to gauge how risky it is to let you borrow funds.
However, your credit score number is not the only criteria lenders examine, especially for bad credit loans and borrowers with challenged credit histories. Several other key factors come into play when applying for a loan.
While a low credit score puts you at a disadvantage right off the bat, understanding what else lenders scrutinize allows you to potentially get approved. This added insight also helps explain why some people get denied while others with similar scores are approved.
Let’s dive into the different factors, beyond just your credit score, that lenders consider when evaluating bad credit loan applications.
Income and Employment History
After your credit report and score, the next biggest factor lenders examine is your current income situation and employment track record. This gives them confidence that you’ll have the means to make the required loan payments.
For income, lenders want to see how much you make each month from your job, side hustles, investments, etc. They’ll likely require pay stubs, tax returns or bank statements as proof of stable, recurring income.
The ideal is to have a solid, lengthier tenure at your current job. But lenders also look backwards at your overall employment history and time spent at past jobs. Frequent job hopping and gaps in employment are red flags.
Steady income from the same employer for multiple years demonstrates responsibility and suggests you’ll have money coming in to repay the loan. Minimal, sporadic or undocumented income throws up a caution sign for lenders.
Debt-to-Income Ratio
In addition to just looking at your income, lenders will calculate your debt-to-income ratio (DTI) to evaluate your loan affordability. DTI is the percentage of your gross monthly income that goes towards paying existing debts like credit cards, student loans, auto loans, and loans for bad credit etc.
To calculate DTI, lenders add up the total amount required for your recurring monthly debt payments. They then divide this amount by your gross monthly income. The resulting percentage is your debt-to-income ratio.
For example, if your debt payments total $2,500 per month and your gross income is $5,000, your DTI is 50% ($2,500 / $5,000 = .50). Mortgage lenders typically require a DTI of 43% or less for conventional loans.
If your DTI ratio is too high, it indicates that you are already overextended by having too much debt in relation to your income. This makes a new loan obligation riskier, even if the payments would theoretically still allow you to pay all minimums each month.
Collateral and Down Payments
Unlike unsecured loans like credit cards or student debt, some loans require you to put up collateral. With collateral assets secured on the loan, lenders face less risk of not being repaid if you default.
Having substantial collateral helps offset a poor credit score when applying for bad credit loans. Common types of collateral accepted by lenders include:
- Real estate (for mortgages or home equity lines of credit).
- Vehicles.
- Cash savings (down payment or deposit).
- Investment accounts like 401ks.
- Valuables like jewellery, art, equipment, etc.
For auto loans or mortgages, most lenders require some type of down payment rather than letting you borrow 100% of the asset’s value. Not only does a larger down payment provide more collateral, but it also demonstrates you’ve saved money already towards the purchase – always a positive sign.
Co-Signers and Co-Borrowers
Some lenders allow borrowers with poor credit to offset their risk by having someone else co-sign or be a co-borrower on their loan application. This gives the lender legal recourse to go after a second party with better credit if the primary borrower defaults.
The credit profile and income details of co-signers and co-borrowers are weighted heavily, just like the primary borrower’s information. The better their credit score and finances, the more likely the loan may get approved despite bad credit from the other party.
Co-signers and co-borrowers are both legally obligated to make payments on the loan balance, but there’s one key difference:
- Co-borrowers are equal applicants who have ownership rights to the property or asset being financed.
- Co-signers don’t have any ownership rights but are just equally liable for repaying the debt.
Having a willing third party with excellent credit and income to co-borrow or co-sign can tip the scales in approval for a bad credit loan application.
Loan Purpose and Asset Stability
Another important consideration for lenders is understanding what the loan funds will specifically be used for and the underlying stability of any assets involved.
For example, there are differences in getting approved for a mortgage to buy a starter home versus a junker car. Real estate assets are viewed as more stable long-term investments compared to depreciating vehicles where loans for bad credit are riskier.
Other Compensating Factors
Aside from the main items already discussed, lenders may consider other more subjective factors to help compensate for bad credit scores when making approval decisions. Sometimes these ancillary details can swing a judgment call if everything else is borderline.
Some potential compensating factors include:
- Having substantial cash reserves or liquid assets.
- Living at the same residence for many years.
- Being a homeowner instead of a renter.
- Having the same line of work for many years.
- Family relationship with the lender (nepotism).
- Understandable and isolated cause for credit issues.
- Recent signs of credit responsibility after previous mistakes.
Whereas objective criteria like credit scores, income and collateral have to meet certain approval thresholds, these more subjective bonuses can act as tiebreakers where human underwriters have some leeway.
The Bottom Line
While credit scores are the primary factor used by lenders to screen loan applications, it is crucial to note that they are far from the only deciding factor, particularly for negative credit consumers.
Gather proof regarding your income, clarify any collateral or down payment money available, consider eligible co-signers, explain the loan objective, and put your best foot forward in other subjective elements of your financial profile.