If your loan application is declined, you might not know where to turn or what to do next. You can start by determining the reasons you were denied a loan, how long you need to wait before you apply again, and what steps you can take, right now and in the future, to prevent it from happening again.
Recourse is available for any type of loan, including mortgages, auto loans, credit cards, personal loans, and business loans. Whenever there is a disconnect between the loan you thought you could obtain and what your lender agreed to, it’s worth narrowing that gap to boost the odds of approval when you re-apply for the loan.
Identify the Cause of the Denial
It's important to find out why your loan application was declined before you apply again. Lenders will generally be glad to give you an explanation and are required to provide certain disclosures, so you don't have to remain in the dark about the denial.
The most common reasons for being denied credit are:
- Bad (or no) credit: Lenders look at your borrowing history when you apply for a loan, which is reflected in your credit scores. They want to see a solid history of borrowing and repaying loans. However, you might not have borrowed much, or you might have experienced some challenges and even defaulted on loans in the past, in which case your loan application might be declined.
- Insufficient or unverifiable income: Lenders look at your work, investment, and other income before they approve your loan to ensure that you can make the minimum monthly loan payments. With some loans, such as home loans, lenders are required by law to calculate your ability to repay. Your loan application can be declined if a lender doesn't think you can afford to repay the loan, either because you don't earn enough or the lender can't verify your income with the information you provided.
- High debt-to-income ratio: This ratio compares how much you owe each month to how much you earn. Most lenders use your debt-to-income ratio to determine whether you can handle the payments upon approval of your loan. Your loan application may be declined if it doesn’t look like you’ll be able to take on new debt.
- Lack of collateral: When applying for small business loans, lenders often look at the business owner’s personal credit if the business isn't established enough to have built up sufficient business credit. Unless business owners are willing to personally guarantee the loan or pledge personal assets valued at the amount of the loan as collateral, the chances of getting approved for a loan without business credit are generally slim.
- Other issues: Occasionally your loan application will be declined for less obvious reasons—if you submit an incomplete application or have a length of residence that the lender deems to be too short, for example. Some mortgage loans don’t go through because an appraisal did not come in high enough to justify the size of the loan.
If you are denied credit, your lender is generally required to provide you with a notice of adverse action explaining the source of information that was used against you (credit reports or data from an outside source), the reasons for the denial (defaulted loans, for example), and information on how to obtain your credit reports and dispute inaccurate information in the reports. Reading this notice can give you a good idea of what led to the denial.
Under the Equal Credit Opportunity Act (ECOA), your loan application can't be denied on the basis of race, religion, national origin, gender, marital status, age (provided that you're old enough to sign a contract), participation in a public assistance program, or your Consumer Credit Protection Act rights.
Regroup Before You Re-Apply
Once you have reviewed any disclosures that your lender provided after your loan application was declined, save yourself time and frustration before you apply again and look at various aspects of your financial profile the way lenders do to check for and resolve red flags in your credit:
- Assess your debt and income: Evaluate your debt-to-income ratio to determine whether you have sufficient income to repay a loan. It’s worth asking your lender what they expect for your debt-to-income ratio. In general, a ratio of under 36% can boost your creditworthiness in the eyes of lenders.
- Examine your credit reports: The credit reports on file with the three credit bureaus (Equifax, Experian, and TransUnion) will show you the lenders that granted you credit, the types of credit you received, and your payment history. Review each one to identify problems like late payments that may have led your loan application to be declined.
- Fix errors in your credit reports: If you have errors in your credit report, reach out to the credit bureau that produced the problematic report. You shouldn’t be held responsible for computer errors or the actions of a fraudster. You have the right to have mistakes removed. If you're applying for a mortgage, you can get errors fixed—and your credit score updated—within a few days if you get the lender to request rapid rescoring on your behalf.
- Talk to your lender: If you're not sure whether an aspect of your financial profile will lead to a denial, ask your lender before you apply again whether they anticipate any problems. They’ll gladly explain what matters and what doesn’t, and how long you need to wait before re-applying after negative events like a foreclosure. Using a small, local institution, such as a local credit union makes it easier to speak with a lender in detail about what you need to do to prepare yourself before you fill out another loan application.
Use Short-Term Strategies
There are some actions you can take that generally have an immediate positive effect on your credit score or may even result in approval for the loan:
- Make a large down payment: A substantial down payment on a car or house (at least 20% of the purchase price of a home, for example) may help you get approved. You’ll also end up borrowing less, which means your monthly payments will be lower. Plus, lenders have less at risk with a lower loan-to-value ratio, which compares the loan amount to the appraised value of the property, so they might be willing to approve a loan even if you don't have perfect credit.
- Use collateral: If you’re applying for a personal or business loan, collateral may help you get approved. Offer to pledge something of equal or greater value than the loan amount to help secure the loan. Just be aware of the risks: You could lose your home in foreclosure, or your vehicle could be repossessed if you fail to make payments. Only take risks that make sense.
- Get a co-signer: If your income or credit were not sufficient to get approved, you might have better odds if you add someone else’s income and credit to the application, assuming they have better credentials. A co-signer applies with you and agrees to become responsible for repaying the loan. If you fail to repay, the lender will go after both you and your co-signer, and their credit will also suffer, so only use a co-signer who understands and agrees to take on that risk.
- Apply elsewhere: A denial speaks to just one lender’s opinion of your financial profile. It’s valuable information, but a different lender might have a different view and approve your loan. If you believe that your finances are as strong as you can make them, you don’t have to wait before applying again after a rejection; approach another lender and apply for a loan with them. Try a local bank or credit union, and check with online lenders. With home and auto loans, in particular, it’s best to “bunch” your loan applications into a short window of time of 30 to 45 days at the longest to minimize damage to your credit from too many hard inquiries in a short time period.
Think twice before you use a home equity loan to pay for a vacation or a luxury car. If you fail to make payments on the loan, you could lose your primary home for a non-essential purchase.
Incorporate Long-Term Strategies
Your loan denial might be due to issues in your finances that can't be fixed overnight. If this is the case, consider making deeper changes to your financial profile over time to make it easier to borrow:
- Build credit: Borrowing will be easier in the future if you build a strong credit history. That means you’ll need to borrow and repay loans on time. Your credit will gradually improve, and you’ll likely get better interest rates and fewer rejections going forward.
- Increase income: Earning more is easier said than done, but it’s worth paying attention to your income when you need to borrow money. If you plan to make major life changes that can reduce your income, such as quitting a job or starting a new career, it’s best to pursue them after you’ve been approved for your loan and have established a plan for paying off the debt.
- Bring accounts current: If you’re behind on any of your loans, get up to date with payments so that your credit can begin to recover. That doesn’t necessarily mean paying back all of the debt you owe. Contact your creditors to work out a payment plan, and get a written agreement to remove negative information from your credit reports.
- Pay down debt: Your existing loans affect your ability to get new loans because lenders look at how much you owe relative to your income each month. Reducing debt reduces your debt-to-income ratio and can make you look more financially capable as a borrower. It will also free up more of your monthly income to repay a new loan after approval.
The Bottom Line
If your loan application is declined, don't give up. Take the above actions to improve your finances before you apply again. Some won't require much effort, such as clearing up a negative item on your credit report. Others, like building a thin credit file, will require time and patience. But ultimately, these approaches will make you a better loan candidate, which will increase the odds of getting approved in the future.