The process of getting a loan is intimidating because you know the lender will judge the past financial behavior to determine if you qualify for a new loan. Yet, past actions do not always predict future performance. Consumers can unwittingly take actions that send red flags to potential lenders and could prevent them from approving your next loan application.
Financially Stressed Borrowers
Your financial stress, stresses out lenders.
An underwriter’s job is to establish a level of risk using the information submitted in an application. They want to predict if you are a safe borrower based on income, assets, and past financial behaviors recorded in your credit file.
Activities lenders can see on your credit report includes a history of payments, debt balances versus credit limits, applications for new credit, and public data such as collections, bankruptcy, and foreclosures.
Signs of Financial Stress Found in Your Credit File Include the Following:
Recently Missed Payments
Missed payments in the last 12 months are an indication that you have more current debt than you can manage. The older the late payment, the less it will impact your score and the less of a concern it is for lenders. A late payment three years ago will trouble a lender much less than one made three months ago.
Late payments have the highest impact to your credit score. FICO considers payment history as 35% of the total calculation.
Maxed Out Credit Cards
Not only will credit cards at their maximum limit scare lenders, but it will also lower your credit rating. FICO considers credit balances in relation to credit limits (called the utilization ratio) as 30% of your credit score. Second only to on-time payments.
For the most positive impact on credit, keep balances below 30% of the credit limit.
The credit report shows all open accounts, along with the open date. The report tracks the last seven years of payments and will typically record any past due payments over 30-days late.
The credit report also lists a two-year history of credit applications. While credit applications are a small part of the credit score, (only 10%) an abundance of applications is a red flag to lenders because it makes you look desperate for credit.
FICO made recent changes to their credit scoring model, which bundles multiple applications for the same purpose as one credit request. The change in scoring does not penalize you for shopping around for the best interest rate when making a large purchase.
Making Minimum Payments on Revolving Debt
Credit card debt offers the benefit of low monthly payments compared to balances. However, when you only make the minimum payment on credit card debt, it is a red flag to lenders, because they see it as an indication of financial stress.
High-interest debt paid down with minimum payments can take over three decades to settle, assuming you do not use the card anymore. While creditors make the most money when you carry a balance, new creditors see it as a sign of too much debt.
Debt Trending Upward
Rising credit balances are another sign you are bridging an income gap with credit. If you find yourself charging groceries and gasoline, without paying off the balance at the end of the month, you may have more debt than you can safely manage.
Declining debt balances indicate that you have your borrowing obligations under control. Increasing debt month over month will lead to maxed out credit cards and loan defaults if you do not put spending corrections in place.
Dramatic Changes in Spending
Lenders frown on dramatic variations in spending patterns because it represents a change in your financial status. You want to stay under the radar with average credit usage compared to other borrowers at similar income levels.
Even having a large number of open credit lines can worry lenders because you could run up balances in a short time and be unable to repay all the debt.
Before applying for a new loan, avoid making large purchases, or opening new lines of credit. Take on one new credit obligation at a time and then season the debt before adding another debt payment.
Short Sales, Foreclosures, and Repossessions
Many lenders do not want to lend money to applicants with major infractions such as a foreclosure within the last three or four years, depending on the type of new debt you request.
Bankruptcy is one of the few negative marks that remain on the credit file for up to 10 years. Most derogatory credit vanishes after seven. Even after ten years, many applications ask if you have ever filed bankruptcy, which can permanently impact your ability to qualify for future credit.
A job change, a move, divorce, or legal matters can directly impact your financial well-being and spending patterns. After the initial transition, these changes can also create an image that you are less stable than you truly are. While these scenarios may not be a representation of future spending patterns, it sends a red-flags to lenders.
Negative marks reflecting a period of unemployment, divorce, medical emergency or other financial crisis in the past create a red flag to lenders. However, if you can provide evidence through an appeal, the lender may agree that past credit marks do not accurately represent your current risk.
Someone Else’s Debt
Co-signing a loan for a third party will reflect on your credit report. Lenders will consider you responsible for 100% of the debt payment when considering new debt, even if someone else makes the payment. The co-signed debt can lower your ability to receive new credit.
If the primary debt holder pays late or misses a payment, it will impact both your credit report and credit score. A co-signed loan means you agree to repay the obligation if the primary borrower defaults. In some cases, the lender will remove the debt from a new loan calculation if you can prove the primary borrower has made the payment for the last 12 months (or more).