How to qualify for a personal loan

Personal loans are a relatively quick way to borrow money to consolidate high-interest debts or pay for medical bills, home repairs, or a wedding. Personal loans provide a lump sum you repay in monthly installments, typically with a fixed interest rate. Here’s what you need to know to improve your chances of getting a personal loan with favorable terms.

Key Takeaways:

• Lenders evaluate your credit score, income and debt-to-income ratio.
• Compare offers from multiple lenders through prequalification to find the best rates without affecting your credit score.
• If you have trouble qualifying alone, secured loans or adding a co-signer can help you get approved.

1. Review your finances

Before applying for a personal loan, you’ll want to understand what lenders look for in applicants. Understanding personal loan requirements helps you assess your chances of success and prepare your application properly.

Credit score

Your credit score reflects your borrowing history and how responsibly you've managed debt in the past. It’s an important factor in loan approval, but it’s also something you have the power to improve.

While you may get approved for a personal loan with a credit score of 580, most lenders look for scores of 610 – 640 and higher. Here are a few things you can do to boost your score:

• Pay your bills on time. Payment history accounts for 35% of your credit score. Set up automatic payments to avoid missing due dates.
• Reduce credit card balances. Paying down your balances improves your credit utilization ratio.
• Don’t close old accounts. A longer credit history helps your score. Keep old accounts open even if you rarely use them.
• Don't apply for too many loans or credit cards. Every time you request new credit, it causes a credit check that can drop your score.

Even small improvements to your credit score can unlock better loan options.

If you’re not sure what your credit score is, you can check for free through Credit Karma, many credit card companies. AnnualCreditReport.com provides free weekly credit reports from the three major bureaus.

Income

Lenders need proof that you can repay your loan. Your monthly income demonstrates your ability to make regular payments on time.

When evaluating your income, lenders look at:

• The stability of your income
• How long you’ve been employed
• Whether your income is enough to cover all your expenses, including the new loan

Some lenders have minimum income requirements to qualify for a personal loan.

Debt-to-income ratio

Your debt-to-income ratio shows lenders how much of your monthly income goes toward debt payments. It helps lenders determine if you're carrying too much debt to take on more.

To calculate your DTI ratio, add your monthly debt payments (credit cards, loans, housing), then divide by your gross monthly income and multiply by 100. For example, $2,200 in debt payments on a $6,000 income equals a 37% DTI ratio. Most lenders prefer ratios between 36%-50%.

If your DTI is higher than you'd like, here’s how to improve it:

• Pay down existing debt. Choose the snowball method (smallest debts first) for motivation or the avalanche method (highest-interest debts first) to save the most money.
• Refinance high-interest loans. Replacing expensive loans with lower-rate options reduces your monthly payments and total interest. Lower payments mean a lower DTI ratio.
• Increase your income. A side job, overtime, or asking for a raise all help lower your DTI ratio by increasing the income side of the equation.

Improving your DTI ratio helps your credit score, too. Lower credit card balances improve your credit utilization ratio, which boosts your score.

2. Gather your documents

Lenders will ask you to provide some personal loan documents to verify your identity, income, and residency before approving your loan.

What you’ll need:

• Identity verification: Current government-issued photo ID, such as a driver's license, passport, state ID or military ID. They also will want your Social Security number.
• Income proof: Recent pay stubs, W-2 forms, bank statements showing deposits, or income tax returns.
• Address confirmation: Two recent documents such as utility bills, a lease agreement, mortgage statements, or insurance documents.

If you’re self-employed, you may need to provide a profit and loss statement and 1099 forms.

3. Compare loan options

To make sure you get a loan you can afford, you’ll want to compare your options.

Understanding loan costs

Let’s break down what a personal loan costs with a real-world example. Say you borrow $15,000 at the current average rate of 11.66% APR for 24 months:

• Monthly payment: $705
• Total interest paid: $1,920
• Total cost: $16,920

If you extended that same loan to 36 months, your monthly payment drops to $496, but you'd pay $2,856 in total interest. A lower rate of 8% would save you about $600 in interest over the life of the loan.

When choosing a loan, make sure to consider the annual percentage rate, or APR. It includes both the interest rate and fees, which shows you the true cost of borrowing. Some lenders advertise low interest rates but then charge high fees. The APR combines all those costs into one percentage, making it easier to compare loan offers directly.

Understanding secured vs. unsecured loans

Secured loans require collateral, such as the vehicle on a car loan or the home on a mortgage but come with lower interest rates and easier qualification. The trade-off is that you could forfeit your collateral if you default, and you can only borrow up to the value of what you pledge.

Unsecured loans require no collateral and approval is based on your creditworthiness. You will pay higher interest rates and must meet stricter requirements, but you won’t lose your car or home if you can’t afford to repay the loan.

Consider a co-signer

If you need a loan and don't have time to improve your credit or DTI ratio, consider applying with a co-signer. The lender will consider your co-signer’s finances as well as your own when evaluating your loan application, which can improve the chances of approval. However, a co-signer agrees to take responsibility for the loan if you can't pay, so make sure it’s someone you can trust.

When considering a co-signer:

• Choose someone with good credit and a stable income.
• Make sure they understand their responsibility if you default.
• Recognize that this is a big request that affects their borrowing ability.

Not all lenders accept co-signers, so check on this option early in your search process.

4. Get prequalified

To make sure you’re getting the best terms, it’s a good idea to get prequalified with several lenders. The lender will order a soft credit check and give you an estimate of how much you should be approved to borrow and at what interest rate.

Prequalification is different from loan approval. Approval happens after you submit a full application, including a hard credit check and verification of all documents.

Once prequalified, you'll see estimates of your monthly payments. This will help you determine whether you can fit this payment into your monthly budget and have enough left for savings and other expenses.

If the monthly payment seems too high, you might request a longer loan term, borrow less money, consider a co-signer to get better terms, or wait and re-apply when you’ve improved your finances.

You can apply for personal loans from different banks, credit unions, and online lenders. Comparing offers from multiple lenders helps you find the best loan for your situation.

5. Choose a loan

Once you’ve compared offers and found the best terms, it’s time to choose a loan. The monthly payment should comfortably fit your budget and, ideally, allow room for savings.

Consider setting up automatic payments to protect your credit score and maybe even qualify for an interest rate discount from lenders.

It’s also important to understand that taking out a loan comes with risks if you don’t manage it responsibly. Defaulting on your loan can lead to legal action and make future borrowing much more difficult and expensive.

If you ever struggle to make payments, contact your lender. They may have a hardship program or be able to modify your payment plan.

FAQ

Here are answers to common questions about qualifying for a personal loan.

Can I qualify for a personal loan if I’m self-employed?

Yes. You’ll likely need to show additional documents to prove that you have a stable income. Expect lenders to ask for your recent tax returns, bank statements with regular business deposits, and a profit and loss statement. Having excellent credit and a low DTI ratio will improve your chances.

Will I qualify for the loan amount I request?

Not necessarily. Lenders determine your maximum loan amount based on your credit score, income, existing debt, and their specific criteria. You might qualify for less than you request if your DTI ratio is high or if your credit score has taken a hit. Alternatively, you also might qualify for more than you asked for if your financial profile is strong, but it’s important to borrow only what you need and can comfortably afford to repay.

What happens if I don’t qualify for a personal loan?

If your application is denied, the lender will provide a reason for the rejection. You can use this feedback to improve your financial profile before reapplying. For example, you may pay down existing debt to lower your DTI ratio or improve your credit score. You can also consider alternatives like secured loans or asking a qualified co-signer to join your application.

The bottom line: Qualifying for a personal loan

Research and preparation make it easier to qualify for a personal loan. Try to improve your financial profile before applying by paying down existing debt and making on-time payments for all your bills. Then, compare prequalification offers to find the best deal.

Ready to start your application? Apply for a personal loan with Rocket Loans today.