If you are looking to get a new loan, whether it is a mortgage, auto loan, personal loan, credit card, or something else, a bank or other lender will review and approve or decline your application.
As a former banker, I spent time tasked with reviewing loan applications that came through my branch. There are many misconceptions on how loans are approved. Your credit score is an important factor, but just one small piece of the puzzle. Let’s dive in and take a look at what banks actually do when approving your loan application.
Your credit score – the first glance
Whether you apply for your loan online or in person, the first place the bank will look is your credit score. This simple number works like your old grade point average in school. If you had a high GPA, you had good grades. If you had a low GPA, you had bad grades. Credit scores work similarly, giving a high-level view into your credit before digging into the details.
However, your credit score is just the first hurdle. Your credit score can be an instant disqualifier, but few banks will approve a new loan with a good credit score alone. There are many more steps to loan approval if you have a qualifying credit score.
Your history of payments – credit history
If your credit score is good enough to get past step one, the real analysis begins. The first step I took when approving a loan after checking the credit score was to look at the applicant’s full credit history.
My bank had a system for underwriting loans using old school paper printouts. I would print the applicant’s credit report for the loan file and would manually review with a highlighter. I would mark any late payments and tally them up to look for a pattern.
A 30-day late payment or two wasn’t a big deal, but 90 day late payments were. A pattern of late payments was enough to disqualify an application, even if they met credit score requirements.
Your likelihood of default – bankruptcies and judgements
Assuming the credit history was free of a pattern of late payments, the next section to review was the bottom of the credit report, which contains notes about any past bankruptcies or judgments.
Recent bankruptcies were an instant decline in most situations, though applications rarely made it beyond the credit score check with a bankruptcy outstanding. Judgements were very rare, but did raise an additional flag. Judgements were not an instant decline, but I did note them to follow up and learn more. In some cases, they would be enough to end an application, but that was not a hard rule.
Your ability to pay – debt to income
At this point, the credit review was essentially done, and my focus shifted to the applicant’s outstanding debt, income, and ability to pay for the loan. By reviewing the credit report, I knew at this point that the borrower was responsible with past loans and shows the habits of making on-time payments, but that doesn’t mean they can afford the new loan they want today.