How Do Banks Decide My Personal Loan Eligibility?

Here are the things a lender evaluates when issuing a bank loan.

Whether you want to consolidate debt or pay for a large expense, a personal loan can fund your financial endeavors. But unlike a mortgage or car loan, personal loans aren’t secured by collateral, which is why lenders must be choosier about their eligibility criteria. Lenders typically look at these five eligibility criteria when evaluating an application for a personal loan:

  1. Credit score
  2. Current income
  3. Employment history
  4. Equated monthly installment
  5. Repayment history

A lender wants to give out low-risk loans, which is why it looks at your credit and employment history to get an indication of what kind of borrower you are. Keep reading to learn about the factors banks typically evaluate to determine your personal loan eligibility. Once you know what’s expected, start looking for the best personal loan rates available.

1. Credit Score

The lender’s credit check reveals your credit score, an important factor in determining your personal loan eligibility and your interest rate. Make sure your score is as strong as it can possibly be.

You are entitled to a free credit report each year from all three credit reporting agencies — Experian, TransUnion and Equifax. Get each credit report and check for and address errors that might impact your score. Your credit card issuer might give you access to a free credit score.

You can give your score a quick boost by paying off a portion of debt and asking for a credit-limit increase on current cards. Both of these actions improve your credit utilization ratio — the amount of debt you have divided by your credit limit — which can account for up to 30 percent of your credit score.

Formulate: Your Game Plan for Getting the Highest Credit Score Possible

2. Current Income and Expenses

Other important factors lenders look at are your current source of income and your monthly expenses. Even if you make a substantial amount of money, lenders look at how much debt you’re responsible for on things like credit cards, car loans and mortgages. The lender might also consider your regular monthly bills, alimony and child support.

Lenders use your income to determine your debt-to-income ratio, which equals your total monthly debt payments divided by your gross monthly income. For example, a borrower with $3,000 in monthly income and $300 in monthly debt payments has a DTI ratio of 10 percent. Lenders like to see a DTI ratio of no more than 43 percent, which is the maximum mortgage lenders allow their applicants to have.

Don’t confuse a DTI ratio with a loan-to-value ratio; your LTV ratio is your mortgage loan amount divided by your home’s purchase price or appraised value.

3. Employment History

Lenders want to see established proof of ongoing income and employment stability. Applicants who change jobs frequently or are self-employed pose bigger risks for lenders. 

A good employment history doesn’t necessarily mean you’ve stayed with the same company for several years. Rather, lenders want to see that you have stayed in the same line of work and that your line of employment has been stable.

Self-employed applicants receive closer scrutiny by lenders. You’ll need to provide more in-depth information to establish a history of reliable income if you work for yourself.

4. Equated Monthly Installment

Equated monthly income is the calculation that tells you what your monthly loan payment needs to be in order to pay off your mortgage or other loan on time. You and your lender both need to know this number because it indicates whether you can afford a loan’s payments on your current budget. A borrower’s EMI amount depends on the interest rate and the length of the loan.

5. Repayment History

In addition to checking your credit score, lenders check your credit history and loan repayment history. Unpaid debts can linger on your credit score for up to seven years, which can hurt your score and affect your loan eligibility. Try to lessen the impact of late payments by writing a goodwill adjustment letter to creditors asking them to remove late payment records.

 

Other Personal Loan Eligibility Considerations

Some lenders factor in the amount of the loan and what you plan to do with the money. For example, you might have an excellent credit score and source of income, but the loan amount could be too risky for a lender to take on. A lender might also consider your length of residency and relationship with the bank.

Your personal loan eligibility is determined by many different factors. Using a personal loan eligibility calculator will help you see if you’re a good loan candidate before you apply for a personal loan. Once you secure a loan, make your loan payments consistently and on time so that the next time you need a loan, your lender will be there to help.

Up Next: How to Get the Maximum Personal Loan Amount

Ashley Eneriz contributed to the reporting for this article.