If you need a lump sum of cash to fund your next financial pursuit, be it renovating your house or consolidating your credit card debt, you’re probably assessing your best personal loan options.
But are you a candidate for a personal loan in the first place? Let’s examine five personal loan requirements you should know about—and how to make yourself a more attractive candidate for approval.
What precisely is a personal loan?
A personal loan allows you to borrow money from a lender and pay back the money over a period of months or years in equal monthly installments. Upon opening an account, you’ll receive a lump sum deposited into your account (or, if you’ve requested a debt consolidation loan, the bank may pay your accounts off directly). Your monthly payments will go partially toward repaying the principal you borrowed and partly toward interest charges.
The amount you pay per month hinges on a few factors, namely, the amount you borrow (it’s often possible to request between $1,000 and $100,000), the length of your repayment term, and the interest rate for which you’ve qualified.
You can use a personal loan for nearly anything—so long as the purchase is legal. Some lenders may deposit your funds as early as the same day.
5 personal loan requirements to know
Before you open a personal loan, keep in mind the following requirements.
Debt-to-income ratio
One of the most important details a lender considers is your debt-to-income ratio (DTI). This is the percentage of your gross monthly income already committed to your monthly debts.
As an example, let’s say your monthly gross income is $7,000. if you spend $2,000 per month making payments on credit card bills, an auto loan, and student loans, your DTI is 28.5%.
A tolerable DTI varies by lender, but a good rule of thumb is to try for 35% or less to give yourself the best chance at approval.
Credit score
When approving you for a loan, banks don’t have the luxury of leaning on a deep interpersonal relationship with you to consider your responsible nature and resolve to faithfully pay off your loan. What they do have is a report card of sorts that represents your creditworthiness: your credit score.
Your credit score weighs factors like your credit utilization, payment history, average age of accounts, and more. It helps the lender to decide more than just whether to approve you for a loan; it also plays a part in dictating the amount you can borrow and your unique interest rate.
Credit history
Similar to a credit score, your credit history shows the bank your track record with other previous and current borrowing commitments you’ve made. A lengthy credit history filled with on-time payments and responsible credit habits is a huge advantage when qualifying for a personal loan at a low interest rate.
Reliable income
You may have a solid income at present, but a lender wants to know that those earnings are reliably coming in. What satisfies each lender may vary, but the ability to submit three to six months of paystubs should assuage the bank’s concerns.
It’s worth noting that you cannot typically claim household income (e.g. your spouse’s earnings) on the application unless your spouse agrees to become a co-borrower.
Collateral (secured loans only)
Most personal loans are “unsecured,” meaning you can open them with no collateral. Others may require that you provide assets to cover your loan—such as a vehicle. That way if you default on your loan, the bank can use your car to recoup its money.
Secured loans can potentially come with lower interest rates and more relaxed approval requirements than unsecured loans, but there’s also a very real risk of losing your collateral if you default.
How to give yourself the best chance at qualifying for a personal loan
With these approval requirements in mind, there are a few things you can do to increase your chances for approval:
- Lower your credit utilization: If your credit utilization is high (30% or more), it can seriously affect your credit score. Focus on paying down revolving lines of credit (mainly credit cards) to potentially see a quick increase in your credit score.
- Reduce your current DTI: Your debt-to-income ratio is a major factor when a lender is weighing your ability to repay a loan. Lowering your DTI—again, to 35% or less— can greatly increase your approval odds.
- Avoid opening lots of other accounts beforehand: Opening multiple accounts in a short period of time can be a red flag for lenders. They may think you’re scrambling for funds. For this reason, it can be a good idea to hold off on other loan applications such as credit cards if you plan to apply for a loan in the near future.
- Use a co-signer: If your credit isn’t stellar, or if your income is relatively low, you may ask a friend or family member to cosign the loan with you. Lenders will then consider your co-signer’s credit and income in its decision. Just note that if you can’t pay your bill, the cosigner will be financially responsible for your loan.
- Open a secured loan: While it’s undoubtedly higher stakes than a traditional personal loan, a secured loan will make you less of a risky borrower to the bank. Those who have a hard time being approved for an unsecured loan may have better luck when offering collateral. That said, we strongly recommend anyone considering a secured loan carefully and realistically consider their ability to pay it back.
Alternate ways to borrow money
A personal loan is far from the only way to get money when you’re looking to finance a large purchase or pay down bills. You may also consider:
- Home equity loan: Depending on the value of your home and the equity you’ve built, you may be able to borrow considerably more than a bank would lend you in the form of a personal loan. Home equity loans often have much more flexibility with repayment terms (up to 30 years). Just note that you may experience more fees than a personal loan—and receiving your money is slower-going. Also, you need to be very sure about your ability to repay what you borrow, as your house acts as collateral. Read our guide to a personal loan vs. a home equity loan.
- Credit cards: Whether for emergency expenses or large purchases, a credit card isn’t the ideal option due to its typically high APR. However, some credit cards offer 0% intro APR for up to two years. If you have the credit score to qualify for a card with such an offer, and can pay off your loan before this interest-free window ends, you may well save more money than if you had opened a personal loan.
- Borrow from a friend or family member: Not everyone has the luxury of borrowing considerable sums from someone close to them. If it’s possible, though, this can be a smart way to avoid interest payments and approval standards enforced by a financial institution. Just note you’ll need to make a very clear agreement and stick to it, so as to fulfill your responsibility and avoid damaging the relationship.
The takeaway
When reviewing your personal loan application, a financial institution looks at your credit score and history, your debt-to-income ratio, and your income. And, if you’re opening a secured loan, the bank will also examine the value of the collateral you put forth.
Give yourself the best chance at approval by lowering your amounts owed and DTI. It can also be wise to abstain from opening other accounts like credit cards soon before you plan to open a personal loan.
Frequently asked questions
What is my debt-to-income ratio and why does it matter?
Your debt-to-income ratio (DTI) is the amount of money you pay toward your debts each month divided by your gross monthly income. This gives the bank an idea as to whether you can afford to take on another monthly payment.
Do lenders charge fees when issuing personal loans?
Some (but not all) lenders charge fees when issuing personal loans. Depending on the lender, you may be charged origination fees, administrative fees, or even early payoff fees.
Is there a minimum income needed for a personal loan?
The minimum income needed for a personal loan will vary by lender. The point is that a lender wants to know you’ve got the income to pay for your monthly installments.
Can I use collateral to get a personal loan?
You can use collateral to get a personal loan. These are called “secured” loans, and they protect the bank from losing money in the event that you default. By putting up assets like jewelry, precious metals, or a car, the bank can take ownership of this collateral to effectively pay themselves back.
What credit score is needed for a personal loan?
Most lenders require at least a “fair” credit score, defined by FICO as 580 or above, to be approved for a personal loan. A “good” score or better, usually meaning at least 670, can help increase your odds of approval and your likelihood of getting a low rate.