Getting rejected can be a damaging blow to your self-esteem. In fact, it is even more upsetting when you've worked really hard on your personal loan application just to receive an answer, "No, we don't want to lend you money. We think you are unreliable and untrustworthy." But, but, but, why?! Here are five reasons why your personal loan application may be rejected.
What is a personal loan?
A personal loan is a type of unsecured loan that a lender or financial institution, such as a bank, gives out to a borrower. This type of loan is unsecured because it is not protected by a guarantor, someone who promises to pay the debt if you don't, and there is no collateral or assets that the lender can seize, in case the borrower fails to make repayments. You agree to make fixed monthly repayments during the entire duration of the loan. Furthermore, any missed payments result in a late payment fee and may even an interest rate increase, depending on the lender.
Personal loans are substantial commitments that usually have a loan tenure of at least one year. Failure to pay can damage your credit score, put your assets at risk, and destroy your financial future.
Reason 1: Credit Score
If you are applying for a personal loan from a bank, one of the most important factors is your credit score. This letter grade predicts risk and evaluates how likely you will miss payments or default on a loan. This score is derived from your credit card payments, previous loan payment history, and open lines of credit. The best grade possible is AA, which means your probability of default is less than or equal to 0.27%. You are a perfect borrower and highly reliable. Grades of B or C means that you have a few black marks on your report because of delinquencies or late payments. Grades D or lower is a clear indication that you have defaulted and a previous bank was forced to write off the loan. It is also possible to receive a grade of CX, which means there is insufficient credit activity. You don't have much of history, so the Credit Bureau wasn't able to give you a score.
Most banks prefer borrowers with good to excellent credit scores. If you have a less than stellar credit rating or no rating at all, a bank will likely reject your loan application. Lenders want to know that you are reliable and suitable to borrow money. If your score says otherwise, lenders will view you as a high-risk borrower, unlikely to repay their investment.
Reason 2: Low or Variable Income
As obvious as it sounds, how much you make will determine if you can afford to pay back what you borrow. The minimum income requirements vary by bank and your legal status. For example, to apply for an HSBC Personal Loan, Singaporean Citizens and Permanent Residents must earn at least S$30,000 a year. Foreigners with Employment Passes must earn at least S$40,000 a year.
Another factor is how you earn your income. The ideal borrower is someone with a steady income. As a result, business owners, self-employed people, freelancers, and commissioned-based employees have a more difficult time proving their financial stability. They will likely need to produce more documents showing their income history in order to get approval. Unfortunately, if you don't meet the minimum income requirements or if your income is irregular, you have your work cut out for you.
Reason 3: Insufficient Employment History
In hopes of getting a borrower with a steady income, banks also hope to find a borrower with a regular employment history. This means being at the same job for a period of time. The ideal amount of time varies by lender. However, most want to see that you have survived a new job's probation period and have at least three months of payslips. Furthermore, banks do not want to see you job hopping, let alone career hopping. It is ideal that you stay in the same field of work right before you apply for a personal loan. A consumer who jumps from job to job, even with sufficient income, is not an attractive borrower.
Reason 4: Your Debt-To-Income Ratio (DTI)
Lenders use the debt-to-income or DTI ratio to evaluate your ability to manage the payments. This is separate from your credit score, which calculates your history. Your DTI assesses your current situation by dividing your recurring monthly debt payments by your monthly gross income. A low DTI ratio demonstrates a good balance between debt and income and is ideally less than 36%. Borrowers with high DTI ratios are considered high risk and may run into problems repaying their loans. A high DTI is an excellent reason to reject a personal loan.
Reason 5: Your Total Debt Servicing Ratio (TDSR)
The Monetary Authority of Singapore (MAS) implemented the Total Debt Servicing Ratio (TDSR) in June 2013. This official regulation establishes a framework that limits the total amount individuals can borrow on their mortgage, based on a percentage of their gross monthly income. Although this framework is used to determine mortgage eligibility, all banks and financial institutions must adhere to it. In most cases, up to 60% of your income may be used to repay loans. These loans include your current credit card balances, student loans, car loans, other personal loans, and if you are a guarantor on someone else's loans.
If your TDSR is too high, your personal loan may be denied. Additionally, if you have variable income, we are referring to all the freelancers and self-employed persons out there, only 70% of your total assessed income is counted in the TDSR. Remember when I said that freelancers, self-employed people, and business owners have their work cut out for them? This is another example.
There are numerous reasons that your personal loan application may be rejected. Moreover, your bank may or may not disclose the reasons why they do not want to lend to you. On the other hand, your bank may approve your loan but offer you ridiculously high-interest rates and harsh repayment terms. This scenario is also not a favorable one. However, there are ways that you can make yourself a more attractive loan candidate.
Lenders should want to lend to you. It is a business where their profit is derived from your monthly interest payments. The more loans you take out and the longer the loan tenure is, the more money they make from their relationship with you. A loan agreement can be a win-win for both parties. By taking the time to address a few mistakes as to why your personal loan application may have been denied in the past, your next application should be smooth sailing.