Factors That Determine Loan Approval
What is your FICO?
A FICO score is a credit score developed by Fair Isaac & Company to help lenders determine the risk involved in lending money to any person applying for a loan. It is widely accepted by lenders as one of the most important components helping determine eligibility as well as specific amounts, rates and terms that can be offered. FICO scores range from 300-850. The higher your score, the less risk involved in lending to you. There are approximately 30 factors that influence your credit rating. Some of these factors, such as your payment history, weigh more heavily on eligibility than others. Every factor’s importance varies by person and can change individually as your credit history lengthens. Also keep in mind your score can change daily as new credit is established or paid down/off. All factors can be grouped into 5 main categories:
- Payment History – Do you make your payments on time? Since this determines (on average) 35% of your score, it is certainly in your best interest to make any and all payments on time! Your payment history includes credit cards, car payments, mortgages, student loans and other loan types. Other public records on file, such as a bankruptcy, will be calculated in this group as well. If you have been late on payments bits of additional info, such as how recently these payments were made and how much time elapsed between the due date and pay date, will also factor into your score.
- Outstanding Debt – Most people over the age of 18 have debt. The question is how much? All outstanding balances for credit cards, car loans, mortgages, etc. will determine (on average) about 30% of your score. How many of these accounts have balances? For example, if you can possible pay down significantly or pay off credit card debt, you’ll be in much better shape during loan approval. Eliminating some avenues of credit can demonstrate your willingness and ability to responsibly pay back new loans.
- Credit History – How long have you been establishing your credit? Specifically, how long have your current accounts been opened and how long as it been since you used each of them? This usually determines approximately 15% of your score. If no credit history exists, you should begin by establishing credit accounts and be sure to keep them spotless. The less history that exists, the less the loan amount you’ll likely be able to obtain.
- Pursuit of New Credit – Each time you apply for credit, there is an inquiry into your current credit score. How many inquiries into your credit score are there and how recent were they made? If you recently applied for a VISA card, Nordstrom account and car loan, you may want to hold off applying for a home loan for a few months. Each inquiry may slightly reduce your FICO score and may portray you as someone overindulging in credit. This usually accounts for approximately 10% of your total score.
- Types of Credit in Use – How many types of accounts are reported for ATM cards, car loans, credit cards, travel accounts, or any other type of account where payments are being made? This will usually determine approximately 10% of your final score as well.
Once your bank is aware of your FICO score they may or may not choose to share this information with you. Assuming they do share your score with you, it is important to remember the higher the score, the more likely you are to obtain a loan. Also, a higher score directly translates to lower interest rates. Over time with home loans, lower interest rates can play a significant role in the total amount you end of SAVING! See two examples of home loans below and the amount of money you can potentially save while boasting a great FICO score.
Example of a 30 Year Fixed Rate Loan for $150,000 FICO Score Rate Monthly Payment Payment Over 30 Yrs 760-850 5.71 $871 $313,560 700-759 5.93 $892 $321,120 680-699 6.1 $909 $327,240 660-679 6.32 $930 $334,800 640-659 6.75 $973 $350,280 620-639 7.29 $1028 $370,080
As you can see, over a long period of time you would save much money if you have a good credit rating upon loan application. For this particular loan, you have the potential to save $56,520 over 30 years. That’s money that could potentially be invested into your retirement, used for vacations, a new car or two, etc. etc. It pays to keep your credit score as high as you are able. For larger loans, the savings potential climbs substantially!
Example of a 30 Year Fixed Rate Loan for $500,000 FICO Score Rate Monthly Payment Payment Over 30 Yrs 760-850 5.71 $2905 $1,045,800 700-759 5.93 $2975 $1,071,000 680-699 6.1 $3030 $1,090,800 660-679 6.32 $3101 $1,116,360 640-659 6.75 $3243 $1,167,480 620-639 7.29 $3424 $1,232,640
In this situation, over 30 years, you have the potential to save a whopping $186,840!!! It pays to be dependable! With the money you could save on this loan the possibilities are endless.
Now, a great FICO score will not be the only determining factor in loan approval. There are additional factors that figure into the approval process as well. Some examples include:
- Income – Your current income will also be a significant determining factor in loan approval. Pay stubs for the previous two months as well as W-2 forms for the previous year will be requested to help determine your ability to repay the loan amount.
- Employment History – Your employment history can tell a lender much about your stability. If you’re constantly switching jobs it could raise a red flag. However, as their may be other factors influencing your employment length (such as a spouse in the military), lenders may choose to ignore this factor.
- Down Payment – Do you have a down payment? How much? Being able to provide a down payment can be extremely useful in the loan approval process. It means the amount borrowed will be less than the total cost to purchase the home. In some cases, depending on the amount of the down payment, your monthly payments can significantly drop.
The important thing to remember is that no matter what your FICO score, employment history or income levels are there are things you can do to help improve your chances of obtaining loan approval. Get referrals to local credit counselors or financial advisors to help optimize your resources fully.