“Bill needed a loan of less than $1500 to make a deposit for his wife’s Caesarean section. Labor had set in a month earlier than her due date, and doctors advised immediate assisted delivery. For him, it was more than a loan; an issue of life and death. But for Jane, it was different, she needed a loan of $2565 within five days or she loses her admission into an Ivory League University.’’
They had applied and both waited eagerly for a response from the issuing organization. Their reasons for desiring a loan vary but it was very important to them, but, however important it was, only laid-down financial rules would determine if they would receive these loans or not.
Individuals and businesses borrow for several reasons, while businesses borrow most times for reasons which may range from a need to improve credit rating, meet up with financial demands of their businesses, aid growth and expansion, boost working capital, reinvest for improved revenue, to an attempt at taking advantage of policies or ongoing economic realities, etc., individuals borrow for common reasons like to tackle health or medical emergencies, debt consolidation purposes, to raise venture/ enterprise or business capital, to cover travel or vacation costs, vehicle or other property financings, lifestyle financing, to expand their businesses, for education amongst several other valid reasons.
But, whether for a business or an individual, loans are often requested or taken as a last resort, and therefore a rejection affects the intending borrower in multiple, often undesirable ways. However, despite how important a loan is to the prospective borrower, there are certain guidelines and principles that financial institutions and lending parties (often referred to as ”surplus economic units”) follow in issuing a loan.
If your loan application is declined, you may be come curious on what step to takes next, however it is most rewarding to first determine the reasons you were denied a loan, and what steps you can take, currently and in the future, to prevent it from happening again.
In this article, we are going to unravel the reasons personal and corporate loans are rejected, to help you identify and avoid them to ensure you secure your desired loan.
Below, is a summary of the 16 most common reasons a loan application may be rejected or declined:
- Low credit score, bad or unreliable credit history
- A high debt-to-income [DTI ratio] ratio
- Insufficient or unstable employment history
- Insufficient, inconsistent or unverifiable income cash flow;
- Missing important or incomplete information/paperwork within your application.
- Lack of collateral or credible guarantor
- Incompatibility of loan purpose with lender’s criteria
- Inability to meet the basic requirements
- Disqualification with other lenders
- Engagement in cyclical or arbitrage business.
- Lender’s personal assessment of your character and personality
- Unstandardized or Infeasible Business Plan or Proposal
- Prior indictments or legal standing
- Existence of overwhelming outstanding debts
- Unavailability of credit to the lending institution
- Government policy (ies).
Now, we shall proceed and discuss them to provide better insight on avoidance, to ensure your loan application is successful.
1. Low credit score, bad or unreliable credit history
The credit score or history is the lenders outlook on previous loans. It is a numerical expression based on a level analysis of a borrower’s credit files ranging between 300 and 850, representing and expressing the creditworthiness of the prospective borrower’s, whether an individual or business. This is one of, if not the most important determining factor to whether your application will be successful or not.
The higher the score, the better a borrower chances at receiving a loan. This information is computed from credit history dependent on: number of accounts held, total figures of debt, repayment history, and other factors and sourced from credit bureaus who are permitted to share that information by law.
In assessing a borrower’s ability to repay a loan, lenders use credit scores to make evaluations. While some lenders may publish their minimum credit requirements, others may not. However, if your credit score is low (does not meet the particular lender’s minimum requirement), or there has been a report of default in the past against you, lenders may charge you a higher rate to compensate for the risk of you not being able to repay the loan, it might also lead to an outright rejection of your loan application.
2. A high debt-to-income [DTI ratio] ratio
The debt-to-income ratio compares how much you owe each month to how much you earn. Majority of lenders use your debt-to-income ratio to determine whether you can handle the payments upon approval of your loan.
To calculate your debt-to-income ratio, lenders add up all your current debt and divide it by your income. For example, if your monthly debt payments figures stand at $7,000 and you divide that by your monthly income of $9,000, then your DTI ratio would be 77%.
Such a high DTI ratio as the one above suggest to lenders that you might struggle to afford debt repayment. It is best to aim for a DTI ratio of 35% or less, which is generally considered good.
If your DTI is too high, paying down debt drops your credit utilization ratio and improves your debt-to-income ratio, increasing your chances of approval. Your loan application may be declined if it is doubtful that given your income level, you may not be able to sufficiently handle a new debt.
3. Insufficient or unstable employment history.
This is most particular to personal loan. Financial stability is highly valued and taken very seriously by lenders in considering your loan application.
If your history shows that you switch jobs frequently or do freelance work which is volatile, there are high chances that your loan application will get rejected.
This is because the lender needs to establish you will have a regular source of income to cushion against the risk of lending to you.
4. Insufficient, inconsistent or unverifiable income cash flow; especially as against the desired loan amount.
Along with income stability, lenders look for proof of income to verify you have the ability to repay what you borrow. If your income is below the lender’s threshold, you may be denied, or offered a loan for a lower amount with a possibly higher interest rate.
Lenders generally want to establish that incomes listed on your application has been consistent, so they can assume it will remain so moving forward. So, if you have several/different pay sources, recently changed jobs (in the last 60 days), or have freelance work from multiple employers, it may create inconsistencies in your income calculations. If your income fluctuates because you’re self-employed or do seasonal work, that doesn’t mean your application will always be declined. While your paychecks may not be consistent or predictable, some lenders may be willing to look at your past tax returns so they can compare your income over a longer period of time.
If your income is insufficient for the amount you want to borrow or if it appears unstable from month to month, the lender might reject your application.
5. Missing important or incomplete information or paperwork within your application.
Loan applications always require several forms of paperwork, including employment and income information (including tax returns, pay stubs, or bank statements), a credit report, government issued ID and in some cases collateral documentation for either your business or yourself.
If you are missing some of this information or the details regarding your name, residence, phone number and other account details are inaccurate you are essentially guaranteed to get denied. A lender might reject your application if it’s missing key information or documents.
Ensure all paperwork is intact and accurate before you submit your application for a personal loan again. You may end up not needing some of it, but better to have it handy just in case.
6. Lack of collateral or credible guarantor.
Things do not always go as planned, and when it comes to loans, the collateral is the lenders refuge. Especially when the risk associated with a loan is on the upside, lenders would need business owners to prove a willingness to personally guarantee the loan or pledge personal assets valued at the amount of the loan as collateral.
If you or your business are not able to provide this needed security, the chances of getting approved for a loan without business credit becomes extremely narrowed.
7. Incompatibility of loan purpose with lender’s criteria.
Loans differ in their categories and types, and some if not all loans are targeted at either a particular sector or use. Applying for a loan that has a different objective from the one you wish to expend them on is most likely ending in a declined request.
A lender might have a rule against investing borrowed funds (i.e tuition support loan) or using it for gambling. If you indicated a loan purpose that’s outside the scope of a lender’s rules, your application could be denied.
8. Inability to meet the basic requirements.
Every lender sets its own requirements, but most look for a few basic criteria, such as;
- Borrower must meet the minimum age requirement (typically 18)
- Borrower must be a citizen of a certain country (say U.S., Nigeria, U.K., etc.)
- Prospective borrower must be employed with a valid bank account
Before applying for any loan, ensure to review the basic requirements to ensure you meet them to avoid a decline of your loan.
9. Disqualification with other lenders.
Certain financial laws allow financial institutions to share data with the credit bureau, if a lender finds records of loan application decline from other credible lender, it becomes a pointer you a possible underlying issue and may prompt them to reconsider lending to you.
10. Engagement in cyclical or arbitrage business.
‘’Times change…’’ they say, but, no lender wants the ties to change on their money. They simply want you to pay your principal and interest!
Cyclical businesses operate in a type of industry that is sensitive to the business cycle, such that revenues generally are higher in periods of economic prosperity and expansion and are lower in periods of economic downturn and contraction. Companies in cyclical industries can deal with this type of volatility by implementing employee layoffs and cuts to compensate during bad times and paying bonuses and hiring aggressively in favorable economic times.
Unfortunately, this is not something that can be predicted so both the lender and borrower would be taking risks by going into an agreement. This makes them a liability in certain seasons and when such business owners apply for loans, the lender would be taking a huge risk by granting such application.
11. Lender’s personal assessment of your character and personality.
This may seem quite unlikely but lenders take your character and priority into consideration before granting or declining a loan application.
Beyond being a formal partnership, lenders and borrowers initiate a relationship the moment they sign an agreement and no one ever hopes to be in a “toxic “partnership.
Most lenders even conduct a background check on your character, the lender confirms that you would be a toxic partner, they would rather turn down your request than take the risk because there are many other business owners with a good character out there who need the loan.
12. Unstandardized or Infeasible Business Plan or Proposal.
If you are borrowing for a business. Lenders must be convinced of your overall business strategy as well as the reason you need investment. If your business model is considered unsound, your loan application may be denied.
13. Prior indictments or legal standing.
Prospective borrowers or people/businesses who have been penalized by the law for financial misdemeanor will most definitely be a red-flag to any responsible lender.
14. Existence of overwhelming outstanding debts.
Banks and certified lenders can access your financial profile even if you have availed loans from third party banks/credit institutions.
And while it is not against standard practice to reject the loan application from a borrower who is already owing a loan elsewhere, however, the borrower must be able to demonstrate financial capacity to handle both loan, otherwise, your likelihood of getting the loan decreases.
15. Unavailability of credit to the lending institution.
Credit institutions are also subject to the economic realities of the economies they operate in, and no matter how they wish to honor loan applications, if credit is unavailable to them, they may not be able to lend.
16. Government policy (ies) and or legal prohibitions.
Banks and other credit-issuing institutions operate under the framework of the law. Central banks control the economy using financial institutions. Financial laws might place certain restrictions on institutions or the category of borrowers it can attend to, an intending borrower might be affected in this category and therefore have their loan application rejected.
So, these at the main reasons your loan application may be rejected, study around them and prepare adequately to enable you to get that much-needed financing today!