Getting denied a loan due to bad credit is a painful and discouraging experience, particularly when you’re in a financial pinch. More often than not, having bad credit is a result of poor financial practices such as paying your bills late, using credit cards rather than paying in cash, or overspending on nonessentials.
Bad Credit is a Major Red Flag for Banks and Other Financial Institutions
When you apply for a loan, the first thing that banks and other credible lending institutions do is check your financial status. This means taking a deep and thorough dive into your spending history, as well as any existing financial obligations such as previous loan applications and mortgages. They will also check whether you pay your bills on time or have a habit of frequently taking out new credit lines.
Banks and lending institutions assess your creditworthiness by analyzing your score. A low score (anything less than 580, which is considered to be a score of ‘fair’) makes it difficult to qualify for a loan. And even if you are approved at a low score, the lending institution will likely leverage conditions to make up for your high level of default risk such as requiring a large upfront payment in cash or increasing your interest rates.
Unless you’re in a particularly dire financial situation, it is not advisable to apply for a loan if you have bad credit since there is a good possibility that you will be denied.
If you are rejected for a loan, here is what you need to do:
Understand the Reason for Getting Denied
If you are rejected for a loan, banks, and financial institutions are required under law to send you an adverse action notice. This is a document that gives a detailed explanation regarding the reasons why your application was denied and is typically sent within seven to ten business days following the decision. This notice is usually in written or electronic form, although the lender may also give you an oral report. The language of an adverse action notice follows the Equal Credit Opportunity Act, which states that factors such as a borrower’s race, nationality, religion, or sexual orientation have no bearing on a lender’s final decision.
Once you receive your adverse action notice, you have a 60-day period to request a physical copy of your report. Obtaining your report will help you better understand and rectify the issues that prevented you from obtaining your loan. It is important to note that if your score is cited as one of the reasons why your loan was rejected, the lender must provide at least two examples of specific issues on your report that contributed to their decision.
Review Your Report
You are entitled to one free report from each of the three major credit bureaus (Experian, Equifax, and TransUnion) every 12 months. Carefully review these reports for any errors or inconsistencies that may have contributed to your loan denial.
Since a report can contain much information (particularly if you have a track record of poor spending habits), it can be overwhelming to sort through it. What’s more, you can receive a separate report from each of the major bureaus, so you’ll be left with three different sets of data to look over.
Here’s what you need to look for when reviewing your report:
- Personal Information – your personal information should include your complete name, current residential address, and a working phone number. It should also include your birthdate, social security number, Taxpayer’s Identification Number (if you have one), and employment information.
- Accounts – this section contains all the information about any bank accounts you own. You need to check whether all the listed accounts are yours and whether they are still active. It will also contain any information regarding limits and balances, as well as how the funds within the accounts are used (i.e. bill payments, incoming and outgoing statements, etc.)
- Inquiries – you will find a detailed summary of companies that requested your report in the past. Suppose there is information you don’t recognize such as applications you did not authorize. In that case, this part will indicate if there is any suspicious activity regarding your report such as a fraudster applying for an account in your name.
- Public Records – the public reports portion of a report involves any legal or civil matters. This contains a record of any bankruptcies, foreclosures, civil suits, and liens you are involved in.
Address Credit Report Errors
While rare, there are instances when either errors in your report or fraud committed in your name are the reasons why your loan application was denied. This is one of the major reasons why you should always keep track of your status!
If you find errors in your report or you are the victim of financial fraud, you should immediately file disputes with the respective bureaus. Make sure that you can provide documentation to support your claims, and that you follow up until the errors are corrected.
Improve Your Credit Score
If you are denied a loan application, the best thing you can do with your time is to improve your credit score. Not only will it make you a more attractive candidate for the next time you apply for a loan, but it will also help you practice better financial habits!
- Pay Debts on Time: Make all your debt payments on time, including cards, loans, and utilities. Late payments can significantly damage your score. Pay in cash and in full whenever possible so that you avoid falling into the “pay it later” mindset. Remember, that kind of mindset tends to make you feel complacent and you will likely find yourself in the same cycle of paying bills late! If you’re having trouble keeping up with your bills, you can set your accounts to autopay. That way, you won’t need to worry about keeping track of your bills AND you can pay them off in full. For one-off bills that don’t permit an autopay method, such as medical bills, you should settle them as soon as possible. If you can’t afford to do so, you can contact the billing office and set up a payment plan that allows you to pay off your balance without overdrawing your account.
- Reduce Your Credit Utilization: Keep your credit utilization ratio low, ideally below 30%. A credit utilization ratio measures the amount of credit you’re using compared to your total limit. Ideally, credit lines should only be used sparingly and in dire financial circumstances such as a medical emergency.
- Avoid Opening New Accounts: If you have a history of poor spending habits, you should avoid applying for new cards or loans for two reasons. First, frequent applications for cards will lead to inquiries from borrowers, which can temporarily lower your score. Second, having multiple cards at your disposal can also lead to a “pay it later” mindset since you won’t feel an urgent need to pay off your bills.
Increase Your Income
It should go without saying, but you should also use the period after being denied a loan to increase your income. Take the time to explore new opportunities to increase the amount of money you make, such as taking on a side hustle, improving your marketable skills, or seeking career advancement. Higher income can improve your debt-to-income ratio, making you a more attractive borrower.
Explore Alternative Lending Options
If you need to take out a loan, consider applying with credit unions. Credit unions often have more relaxed lending requirements than traditional banks and you might be able to find more favorable terms and higher approval odds. However, keep in mind that unions often charge higher interest rates than traditional lenders and might give you a shorter repayment period to offset the risk of lending you money.
Should worse come to worst, peer-to-peer (P2P) lending can also be an option. P2P lending involves borrowing money from a private individual or business to avoid an intermediary such as an official lending institution. While using these kinds of services can be suitable for when you are in a desperate situation, borrowing via P2P lending comes with substantial risks.
Since they are private individuals, you will not be able to receive any kind of government protection in case something goes wrong during the transaction, such as P2P lenders charging usurious rates or adding disadvantageous clauses in your contract’s fine print (i.e., promising a certain amount for lending then giving you less due to hidden fees). What’s more, some states don’t allow P2P lending. Legislation in Iowa, Idaho, Maine, North Dakota, and Nebraska makes P2P lending illegal.
Seek Financial Counseling
Consulting a credit counselor is one of the best ways to improve your financial habits. There is no shame in seeking guidance from a non-profit financial counseling agency. Financial counselors are bound by law to keep your conversations private and they can provide personalized advice on debt management, credit repair, and improving your financial situation.
You must be honest when you seek financial counseling. Being transparent about your spending habits, especially those that stress your financial situation such as overspending on luxury items, gambling, or having vices such as smoking or drinking, will help you identify and address your biggest spending areas.
The great thing about getting financial counseling is that there are affordable and reliable resources! You can reach out to the Financial Counseling Association of America and become a member to access their services.
Consider a Cosigner
If your score is still low, consider asking a trusted friend or family member with a good score to cosign on the loan. Their strong score may improve your chances of approval. However, asking a friend or family member to become a cosigner is a big responsibility! If you default on your loan, you will also damage their status and you might end up in a situation where there is bad blood between you and your cosigner.
Before you consider asking for a friend or family member to become a co-signer, make sure that you are in a good position to fulfill your financial obligations.
Reapply ONLY When Ready
You should wait at least six months to a year before reapplying for the same loan or a similar loan from another lender. This gives you time to improve your score and financial situation. During this period, you should already practice better spending habits so that you won’t fall into the same problematic situation in the future.
Final Thoughts
While it may seem hopeless right after being denied a loan, remember, that getting rejected doesn’t mean you will forever be shut out of future opportunities. It only means that you need to take a long, hard look at your financial situation and learn from your mistakes. According to Forbes, nearly a quarter of Americans were rejected for loans in 2023, so you are not alone.
By taking the aforementioned steps to address the reasons for denial and strengthening your financial standing, you can increase your chances of qualifying for loans in the future. If you need help in managing your financial situation after getting denied a loan, call our experts today! Here at Clean Credit Clinic, we are happy to assist you in managing your financial status for a stronger, brighter, and more stable future for you and your loved ones.