It’s always nice to know that approval is guaranteed before putting in your actual loan application. Is that possible? Well, kind of. With modern technology, you can get pre-approved in a matter of minutes, provided that you fit the criteria.
That’s always the caveat, isn’t it? Most consumers get flooded with offers of “pre-approved” funding. Read the fine print. It’s typically only pre-approved if you have a certain credit score, make a specific amount of money, or have a good, long-standing credit history. (If a lender tells you that you’re pre-approved without knowing any of your info, run for the hills—it’s probably a scam.)
Of course, there are exceptions to every rule. Debt consolidation loans are a good example. Pre-approval standards for those are more relaxed, since they’re basically designed for people with bad credit. You can, however, get better terms if you have a higher credit score.
Understanding how your credit score is calculated
Your credit score determines whether you’ll get a loan and what the terms and conditions will be after you’re approved. Raising your credit score increases your chances of getting pre-approved. Four of the main variables in calculating your credit score are:
- Total credit usage: Try not to “max out” your credit cards. That will hurt you when you apply for a loan. Lenders like to see a credit utilization ratio of 30% or less.
- Payment history: Do you make all your monthly payments on time? It’s okay to be late occasionally, but a consistent record of late payments will lower your credit score.
- Length of credit history: Always keep your oldest credit account open, even if you no longer use that credit card. The longer the credit history, the better the credit score. Open, unused credit can also help lower your credit utilization ratio.
- Credit diversity: A good example of credit diversity would be having a credit card, a personal loan, an auto loan, and a mortgage. Mixed credit indicates financial stability.
Pay attention to your finances in each of these areas to keep your credit score up—and for overall financial peace of mind. Believe it or not, life is more manageable when you pay your bills on time and rely more on cash than credit cards.
Debt-to-income ratio doesn’t tell the whole story
Yes, your debt-to-income (DTI) ratio is also a variable in calculating your credit score, but we’re giving DTI its own section because far too many consumers borrow more than they can afford to pay back. Being “pre-approved” doesn’t necessarily mean you should apply for a loan.
Calculating your DTI ratio is simple. How much money do you make and how much do you owe? Typically, this is calculated on a monthly basis, so we use monthly income and minimum monthly payments. That’s okay, but it doesn’t tell the whole story.
The real question is: “How long will it take, based on what you’re paying out per month, to pay off your entire debt?” Getting another personal loan, unless it’s a debt consolidation loan, will add months and maybe years to that number. Are you prepared for that?
Lenders will tell you, based on your DTI and credit score, that you can easily afford another loan, so they pre-approve you. That’s great if you really need the money, but make sure you’re prepared to pay the price for it. If so, go for it. If not, it’s best to think twice.