Most people know one thing about credit scores: the higher, the better. But your credit score is an aggregate figure drawn from an incredibly complex, opaque process. It’s often difficult to understand what a given score can actually get you.
There’s no guarantee that lenders will extend a line of credit. When it comes to personal loans, you can generally expect a lender’s approval if you have decent credit. So, how good does good credit have to be to make loan approval more likely? And how can you get your credit score to that level?
If you’re like most people, using financial tools like personal loans and other lines of credit feels pretty confusing. Prospective borrowers considering a personal loan can read through this guide to find out all about:
- Their credit scores
- What comprises them
- How to improve them to make loan approval more likely.
How is My Credit Score Determined?
The big three credit bureaus – TransUnion, Experian, and Equifax – track things like payment history, the number of lines of credit, age of accounts, and number of inquiries to establish a kind of borrower’s profile. While these credit bureaus have released information over time to help people build better credit, the majority of their internal procedures are secret.
FICO establishes its score based on the borrower profiles of the big three credit bureaus. FICO has also not disclosed the entirety of the process it uses to arrive at the final credit score, but there are a few things revealed to have some impact on your FICO Score:
Payment History (35%)
Lenders want to know how well you’ve paid back loans and accounts in the past, which is why payment history makes up such a large part of your FICO score. Things like retail accounts, credit cards, mortgage loans, and installment loans are all considered, as well as the presence of things like bankruptcies, wage garnishments, and other lawsuits, especially ones from collection agencies.
Amounts Owed (30%)
The second most important category is how much you currently owe. Maintaining a high balance on your accounts over a long period can cause your credit score to go down. The thinking here is that if you’re already making tons of payments, then it’s unlikely you can take on a new one. However, evidence that you use credit tools will help your credit score rise, so you shouldn’t aim to keep your accounts zeroed out all the time.
Length of Credit History (15%)
FICO doesn’t only like to see that you’ve had accounts open for a long time; they also want to see those accounts being used frequently. Not only will this show that you have some degree of financial literacy, but it also demonstrates reliability as a borrower.
Credit Mix (10%)
Lower risk borrowers are more likely to have a variety of accounts. Lenders don’t want to see that you’ve been taking out short-term loans exclusively for years. Lenders want you to have a number of different accounts like a mortgage, car payment, retail card, and credit card, all of which have a healthy payment history. Borrowers with a variety of accounts show they can manage multiple things at once without falling behind.
New Credit (10%)
The number of inquiries from lenders – also known as a hard credit check – reflects poorly on individuals who have lots of them in a short period, especially for those with short financial histories. Don’t open accounts or search for loans too frequently because they will stay on your record and possibly lower your credit score for two years.
This is one of the advantages of finding your personal loan through Payday Loans Pro, whose network of lenders don’t run hard credit checks.
- Having a good credit score can help you secure a larger loan while having a bad one can prevent you from getting one.
What is a Good Credit Score?
Financial institutions group credit scores into ranges. For classic FICO scores, the ranges are as follows:
- 300 – 579 is considered a poor credit score
- 580 – 669 is a fair credit score
- 670 – 739 is a good credit score
- 740 – 799 is a very good credit score
- 800 – 850 is an excellent credit score
Minimum Credit Score for a Personal Loan
No lower limit is defined to qualify for a personal loan, but you can generally assume that a lower credit score will make your loan application less likely to be accepted by a financial institution. Even a fair or good credit score might be denied based on the particular characteristics of your credit.
For example, even a fair or good credit score might not get you approved for a loan if your credit is very new, recently recovered from a lower score or your debt-to-income ratio is too lopsided.
Most lenders approve loans to people with credit scores in the 600s. That’s not a hard credit score requirement, but people with scores lower than 600 tend to have a very hard time securing any kind of loan.
Good Credit Loans vs. Excellent Credit Loans
If you are approved for a personal loan with a less than ideal credit score, the loan terms might be less flexible. Your loan options will be more limited broadly speaking and your monthly payments will probably be higher. Borrowers with very good or excellent credit are usually offered lower interest rates, higher loan amounts, and more generous repayment plans.
Some financial institutions might also charge an origination fee, which is a set amount required to open an account or line of credit. Origination fees can be anywhere from 1 – 8% and typically vary according to the borrower’s credit score.
Excellent credit loans are more likely to have relaxed repayment terms and require less collateral. People with excellent credit scores typically get cold loan offers without even applying, although a high number of these loan offers may not be from reputable lenders.
The Logic of Lending
Many people are confused by lending logic. It’s a bit counter-intuitive to give higher interest rates and stricter repayment options to people with limited financial means – surely those with better credit histories are the ones who can actually afford to pay more.
Financial institutions can’t operate on such assumptions, though. They lend money to make a profit with interest rates and people with worse credit scores are viewed as being a greater risk for the lender.
Since they’re taking a greater risk granting personal loans to people with lower credit scores, these institutions try to get money from people with bad credit up-front, through origination fees or higher annual percentage rates (APRs), just in case the borrower defaults before the end of the repayment period.
What is Creditworthiness?
Credit scores define your creditworthiness. Some researchers have even tried to link credit scores to predictors and consequences of disease because of the correlation between credit scores and socioeconomic factors that also produce bad health outcomes.
In short, even if you aren’t planning on taking out a new loan, being creditworthy in the eyes of financial institutions can still help you. Repairing your credit score is also a long-term goal, frequently taking years to accomplish. It’s never too early to start.
How to Get Better Loan Terms With Bad Credit
The key to getting more favorable loan terms is to reduce the risk to the lender. You can do so in a few ways.
Guarantors, or someone who signs on to take responsibility for the loan if the borrower defaults, are one of the most common ways for people with bad credit to get loans. Many people who take out student loans are quite young and may have no credit history at all, so their parents or other family members typically have to act as cosigners.
Some lenders require proof of income with a personal loan application. This is another great option for people with bad or limited credit histories if they consistently have a relatively high balance in their bank account.
Collateral is another way people with existing assets can present themselves as less of a risk to lenders. You can offer up personal property like a vehicle or a house if you want to take out large sums of money.
All of these methods are varieties of what’s called a secured loan. An unsecured loan is one where the borrower fills out a loan application without a cosigner or any kind of collateral. Unsecured personal loans given to borrowers who have low credit scores generally come with high-interest rates.
How to Improve Your Credit Score
So, what can you do if lenders deem you uncreditworthy? Improving your credit score isn’t about having tons of money so much as it is about using your means strategically. If you want a personal loan from a lender who performs hard credit checks, try one of the following methods:
1. Maintain Healthy Credit Card Balances
Many people make the mistake of mothballing their credit cards. Remember that credit utilization is part of your FICO score – it’s not that your credit card debt should always be at zero, but rather that your cards should have a balance that you pay off reliably.
2. Make On-Time Payments Consistently
Payment history is the most significant determiner of your credit score and one of the reasons improving your score takes a long time. Late payments can put a dent in your score that could take years of on-time payments to rectify.
3. Limit Hard Inquiries
Most institutions that might extend a line of credit will check your credit score and each time they do so your credit score will take a hit. It’s not a significant dip if it’s one hard inquiry once in a while, but multiple hard inquiries in a short period imply that you’ve fallen on hard times, which is guaranteed to hurt your creditworthiness.
One great way to limit hard inquiries is to go through one of Payday Loans Pro’s trusted lenders who don’t perform hard inquiries on prospective borrowers’ credit profiles to determine eligibility.
4. Keep Your Lines of Credit Open
Even if you have a credit card that’s zeroed out, you shouldn’t close it. Doing so will ding your credit score because it might lower the average age of your accounts and affect your credit utilization rate. If all your credit cards are at zero, then closing one will have less of an effect on the utilization rate, but it can still hurt your credit scores if you’ve had the credit card for a long time.
5. Be Wary of Debt Consolidation
Taking out a line of credit to pay off your loans so you can concentrate on just one loan payment instead of several is called debt consolidation. It can be really convenient but the hard credit inquiry for a debt consolidation loan will still hurt your credit score just like any other one would.
If you are consolidating your debt with a loan or a credit card, a huge amount of your creditworthiness will hang on your payment history for that consolidated account. It is absolutely essential to make on-time payments on lines of credit used for debt consolidation.
6. Diversify Your Credit Profile
Using different financial tools and paying them off regularly makes you look like a reliable borrower with high financial literacy. Lending to someone with a diverse credit profile is lower-risk for lenders. Make sure you have a healthy mixture of credit cards with high credit limits, car loans, student loans, and mortgages or home equity.
- Most banks will usually run a free credit report for you.
How Can I See My Credit Score?
Many banks and credit unions offer their members free access to their own credit scores. Americans are entitled to a copy of their credit score from each of the three big credit bureaus once a year, which can be found here. These credit reports won’t have your credit score number on them, but they will let you see what needs repairing in your credit profile.
If you have a credit card, the company sponsoring it might give you your credit score for free. Some online resources also offer this option, but be careful because they might be using a different aggregate than your FICO score and give you the wrong idea about the state of your credit.
What is a Good APR?
The best way to know if you’ve received a good loan is to look at the annual percentage rate or APR. The lower the APR, the better for the borrower. However, the length of the repayment term also affects APR.
For example, the average APR for payday loans is 391% but these loans are generally very short-term, often lasting just one week. The reason an annual percentage rate is higher than a long-term loan is that it only applies for a tiny fraction of the time.
Average APRs for credit cards have been hovering around 14 – 15% for the last couple of years. That might sound much lower, but credit cards typically have much higher credit limits and carry higher balances than short-term loan accounts.
What Are the Best Personal Loans for People With Bad Credit?
The best personal loan for you will change depending on what it’s going to be used for.
Payday loans are stopgap solutions meant to hold you over until your next paycheck, so the terms should be geared toward paying the loan off fast.
Mortgages are often meant to last for several decades and so the loan terms should be clear about how refinancing and paying off the loan will work. Car loans are somewhere in between, but just like home loans and mortgages, they should be clear about ownership because cars and homes are two of the biggest personal assets you can have.
If you’re looking for a short-term personal loan, the fastest and easiest way to apply is to use our Payday Loans Pro. Sometimes you can even get approved for a loan on the same business day.
The most important thing you can do as a borrower is to make sure you’re using a reputable lender. All the rules we’ve discussed so far in this guide are by and large accepted, but some disreputable lenders hide tricks in their terms of service or loan agreements.
They may also be targeting people with low credit scores, assuming these people are the most likely to be less financially literate and agree to unfavorable terms like high APRs and long repayment plans. Read everything you sign and make sure you understand everything you’re agreeing to because undoing damage from a bad loan can wreck your credit score and take years to repair.
Lenders decide whether they want to take on the risk of a new loan. Credit scores heavily impact their decision, but there’s no definitive credit score requirement for a loan unless it’s defined by the lender.
One thing that’s certain is that a higher credit score will make approval much more likely and could speed up the loan application process. Use some of the tips in this guide to boost your creditworthiness so you can get a loan if you ever need one.