A personal loan is one of the simplest lending products there is, you borrow money and pay it back with interest over an agreed period. What’s less simple is how lenders work out who to approve for a loan – the process is often hidden from view.
What do lenders want?
When writing a loan, a lender is trying to work out the likelihood that a customer will be able to repay it. No loan is 100% safe, but lenders try to charge enough interest so that even if a few borrowers default, the lender can still make enough money to stay in business. No lender knows for sure who will pay them back in full. However, there are two questions they can ask to get an idea, firstly does the borrower have a track record of repaying debt? And secondly can they comfortably afford repayments for the loan?
For most lenders, the first question is the most important. So, they will carry out a credit check using information from credit reference agencies such as Experian and TransUnion to examine your credit history and in particular your credit score. A credit score is a number anywhere between 300 and 1,000 that depicts your creditworthiness -each credit agency has a slightly different scoring system, there is no such thing as a ‘universal credit score’. And the higher your score, the better you will look to a potential lender
The question of affordability is also important, but because lenders don’t always independently verify affordability information it can be less of a factor when determining whether you get a loan or not. So how can you help ensure you get approved for a loan?
Work on your credit score
There are steps you can take to monitor and improve your credit score. Some are obvious, such as making sure you are repaying any existing debts you have on time. However, there are also quick fixes you can make, for example making sure you are on the electoral roll or fixings any mistakes that may appear on your credit file. For more information on getting to grips with your credit score you can read our article here: https://www.transaveuk.co.uk/understanding-your-credit-score/
Make sure your loan is affordable
The other side of the coin is affordability. When writing a loan, responsible lenders want to be sure that you will be able to comfortably repay it.
So, if you have £300 per month left over after meeting your obligations (rent, food bills, petrol etc.), but monthly repayments would come to £280 per month, this might be a red flag for a lender. The lender would worry that you might not be able to meet your repayments – in particular, if you have a change in circumstances.
They may also consider your debt-to-income ratio, which is a slightly simpler way of looking at things since it doesn’t factor in what proportion of your income is tied up with monthly expenses.
It’s worth doing some homework yourself to work out what you think you can afford, leaving yourself a sensible buffer. While you can increase the loan term (i.e. pay it back over a longer period) in order to reduce your monthly payments, it’s important to bear in mind that you’ll repay more in total interest this way. Of course, reducing the loan amount is the easiest and best way to increase affordability.
Find a lender that offers loans based on affordability
The challenge when it comes to writing loans based on affordability is verification. When a lender checks your credit history, that information comes from a reliable source. Credit bureaus keep (usually) accurate, detailed records on things like missed payments, loans paid off in full, CCJ’s and the like.
But it’s much tougher for a lender to check affordability – that’s because most lenders can’t independently verify your income or monthly spending. This is where Open Banking technology comes into play. Using Open Banking, lenders such as TransaveUK are able to securely view your bank account information and verify the affordability of a given loan for you.
As a result, they are able to rely on affordability, placing less emphasis on a credit score, meaning you might be able to access a loan even if you’re credit rating is classed as ‘fair’ or even ‘poor’. Bear in mind that in some cases the lender may offer you a lower amount than you applied for based on what they think you can afford.
Avoid the payday loan trap
Following these above steps should help to ensure you can access an affordable loan without having to resort to expensive credit options such as payday loans which are relatively easy to obtain, but are also very expensive and can make it harder to obtain other forms of credit in the future.