If you’ve ever been in a position where you need a loan for either a home purchase, car, home improvements, debt consolidation or other things, you may wonder how to get approved for a bank loan.
Banks, by definition, are typically risk-averse, so they will have stringent requirements for borrowers. As a result, bank loans are not a quick and easy resource if you need money right away, as they tend to thoroughly vet borrowers.
Although the paperwork and requirements for a bank loan can seem overwhelming, they are usually straightforward. Banks tend to verify every detail possible regarding your personal information so that they can assess how likely you are to pay off your loan, as well as where to find you should you fall behind on payments.
We’ll explain what it takes to get approved in this post.
Bank loan options
There are generally two types of personal loans offered by banks — an unsecured loan and a secured loan. Each has its own merits and requirements. If you’re someone with a solid credit score and good income, you should have no problem qualifying for an unsecured loan. But if your credit is less than stellar or you don’t have a steady income, a secured loan may be your only option.
Unsecured personal loan
An unsecured personal loan is a fixed loan amount that doesn’t have any collateral or asset tied to the loan. You don’t have to pledge assets like a home or a car to be approved for the loan. Typically, these loans are approved based on creditworthiness and your ability to repay the loans.
Many people use unsecured personal loans to consolidate debt, improve their homes or cover expenses like a wedding or vacation. With this type of loan, you should know about lenders’ fees, prepayment penalties and the interest rates when shopping around for the best rates on personal loans.
Secured personal loan
A secured personal loan requires you to pledge property (collateral) such as a home, automobile or money in a savings account or certificate of deposit (CD) in order to borrow money. In this scenario, you are borrowing against the value of an asset.
You may need a secured loan if your credit profile is not strong enough to qualify you for an unsecured loan. In this scenario, if you fail to make timely payments on the loan, the property you pledged could be seized by the lender. So think carefully if you are 1) able to make timely payments on this kind of loan 2) willing to put your assets at risk in case you cannot make payments on time.
Requirements for a bank loan
Credit score and history
Banks are in the business of getting solid returns on the money they lend to customers. For this reason, they will do everything they possibly can to prevent losses caused by borrowers who default on loans.
Banks will scrutinize every loan application against strict criteria that consider, among many things, your credit score and history. This information can be found in your credit report. Some banks may not extend personal loans to borrowers with a recent bankruptcy on their files, for example.
Some lenders have specific minimum credit score requirements. To get the best personal loan rates, you’ll need to have a score in the high 700s, but you may be able to qualify with a score below 600 at some lenders. If you want to know what constitutes a good credit score, here are the five components of your credit score:
Consistent and sufficient income
Banks want to know that you have sufficient income to service your debt. They will verify your employment history to make sure you have a consistent history of working. (Being a freelancer, running a business, or making multiple job changes in a short span of time can signal to banks that you have inconsistent income.)
A solid debt-to-income ratio
Banks want to know how much outstanding debt you have because it will affect your ability to repay your loans. In order to figure out what constitutes as “too much” debt, banks will calculate your debt-to-income ratio (DTI.) This number is the sum of all your monthly debt payments divided by your monthly (gross) income.
For example, let’s say that your total monthly debt obligations add up to $2,000 and your monthly take-home pay is around $4,500. This means that your DTI is around 44%.
Each bank has its own thresholds for debt-to-income ratios based on the type of loan you are getting and a number of other factors. However in most cases, if your debt-to-income ratio is too high, you could be denied a bank loan. The bank may believe that lending you more money could cause you to be financially overextended and eventually default on one or more of your loan obligations, including theirs.
Aim for a DTI of 36% or less to have the best odds of approval for a personal loan.
Your assets typically only come into consideration when you are applying for a secured personal loan. If you will be borrowing against the value of your home, car or any savings, you could be required to give detailed information to the bank about the value of these assets.
In the case of a car title loan, for example, the bank will determine how much you can borrow by assessing the value of your vehicle.
If you have poor credit, a cosigner can help you get approved for a bank loan or secure a lower rate than you might have normally. This is a big risk for the co-borrower, so don’t ask this of anyone lightly. If you are unable to repay your debt, the bank will go after them to recoup the debt.
Pre-existing relationship with the bank
Credit unions and community banks are known for working closely with their customers to help them find the best financial resources for their needs. They may be more willing to work with borrowers who have poor credit, low income or negative marks on their credit files if that borrower is an existing member of the bank.
What you plan to use the loan for
More often than not, most bank loans will have an explicit and specific purpose. For example, a mortgage loan can only be used to purchase a home. A car loan can only be used to purchase a car and a private student loan is designed to cover educational expenses, and so on.
In the case of some personal loans, you are able to use the loan for a long list of needs — from weddings to debt consolidation. There are a few exceptions such as gambling or other illegal activity. Though you may be able to get away with using loan proceeds for prohibited purposes, your lender could try to seek out this information. It’s best to comply with the terms of the loan agreement and use the loan funds as you indicate on your application.
Why it’s important to shop around for a bank loan
Trying to find the best rate for a bank loan can seem daunting but it’s worth it. If you are able to find a bank with just slightly lower interest rates, it could save you hundreds or even thousands of dollars in interest and fees down the line. For this reason, you should compare your loan options and shop around to get the best rate possible.
If you’re handling your finances correctly, you probably hope that you’ll never have to borrow much money — because it can be such a frustrating experience. In the case that you do borrow money, make sure that you research your options and work with a bank that will extend the best terms and even better customer service.
It also doesn’t hurt to keep your personal credit profile intact in case the need to borrow money does come up. With a good credit history and plenty of research under your belt, you should have no problem finding the best personal loans for your needs.
At the end of the day, it’s important to understand your borrowing needs and find the best financial institution that will lend to you in an affordable and responsible manner.