Beyond Your Credit Report: What Else do Lenders Consider?
We all know lenders look at our credit score and information from our credit report when deciding whether to lend us money, but that’s only one piece of the puzzle. A stellar credit score and a spotless record will position you well to access credit, but there are other parts of your financial life that play into a lender’s decision to offer you credit or the best rates. So, what else do lenders consider beyond your credit report?
Income and Expenses
No matter what type of credit you are applying for, almost every lender will ask you about your income. Lenders often compare your income to your other expenses, debts, or obligations to determine whether you’ll be able to repay your loan. The income they ask about can include your salary from a full-time job, or other sources of income like a pension, disability pay, or investment income.
In some cases, a lender may be satisfied with your self-reported income, but in other cases you may need to provide proof of your income, such as a pay stub or a copy of your tax returns. Depending on how you earn your income, providing proof can be tricky. For example, if you earn a large portion of your pay in cash you may need to show several months’ worth of bank statements in order to verify your income.
While a higher income generally signals that you are more likely to be able to repay your loan, it’s really not that simple—lenders want to know how much your income is off-set by your regular expenses and debts. Two common measurements used by lenders to answer that question are disposable income and debt-to-income ratio.
Disposable income is how much income you have left over after any required monthly expenses. Many lenders will use disposable income instead of your gross income to determine how much cash you’ll have available each month to repay your debt. A lender will calculate your disposable income by starting with your gross income and subtracting any regular expenses or debts. For example:
|Gross monthly income||$5,000|
|Monthly Debt Payment (from your credit report)||-$1,000|
Debt-to-income ratio measures how much you owe each month compared to how much you earn. Many lenders use DTI to judge your ability to manage your monthly payments. The lower your DTI, the less risky you appear to lenders. A higher DTI suggests that you might be overextended and have a hard time repaying additional debt.
Calculating your debt-to-income ratio is easy: add up all of your monthly debt bills (such as a car payment, rent or housing payment, and your credit card payments) and divide by your total monthly income before taxes. The result is a percentage known as your debt-to-income ratio, or DTI.
DTI = Total Monthly Debt Payments / Total Monthly Income
What’s a good DTI ratio?
There isn’t a magic number, but in general, the lower the better. DTI requirements also vary depending on the type of credit you’re applying for. For example, 43% is usually the highest DTI you can have and still get a qualified mortgage.1
How do you lower your DTI?
If a high DTI ratio is preventing you from getting the credit you need, you can either lower your debt levels or increase your income. For most of us, increasing our income is easier said than done. Lenders may allow you to apply with a co-applicant or add a co-signer and have that person’s income considered as part of your application, which may help you get approved.
If those aren’t options for you, it’s time to focus on reducing your debts.
- As a first step, stop taking on more debt. Stop using your credit cards and cancel those unused subscriptions – do whatever it takes.
- Next, evaluate your options for paying down your debt. You might be able to lower your credit card payments with a balance transfer or with a debt consolidation loan.
- Lastly, reevaluate your budget and figure out how you can reduce your spending for the long haul.
Although your debts are on your credit report and impact your credit score, your income level and your DTI ratio are not in your credit report and do not directly impact your credit score. That said, if you have a high DTI ratio you might also have a high credit utilization ratio, which does have a major influence on your credit score.
Savings and Other Reserves
Lenders generally expect you to use your income to repay a loan, but some lenders want to know how much money you have in reserves in case you lose your job. These reserves can be in various forms, as long as it would be relatively easy to access the money and use it to make payments. The most common form of reserves they consider is money in a checking or savings account, but some lenders will also consider funds in a money market account or other investment accounts. If a lender wants to check to see how much you have in reserves they will usually ask for few months’ worth of account statements to prove how much you have in reserves.
Your employment history is often of interest to lenders because it helps them to assess how stable or reliable your income is, and therefore how confident they are that you’ll be able to repay the loan. A lender may ask you to provide several months of paystubs or they might call your employer to verify your employment history.
For secured loans like a mortgage or a car loan, lenders want to know about the value of the collateral. This information is important because you are pledging the collateral in case you fail to repay your loan. In general, lenders will offer you a loan for less than the value of your asset. For example, with some lenders you can get a mortgage for 80% of the value of a home—meaning, if your home is worth $200,000, you could get a mortgage for up to $160,000.
To assess the value of your collateral, the lender will order an appraisal on your home (for a mortgage or HELOC) or ask for your Vehicle Identification Number so they can access the vehicle history and look up its current value (for a car loan). Depending on the value of the collateral, a lender may decline your request for credit or they may simply raise the rate on your loan offer. This is because a lower collateral value means the lender has a lower chance of recouping their money if you fail to repay your loan.
What lenders DON’T consider
We’ve looked at some of the things lenders consider when making a credit decision, but what are the limits? Different agencies and laws regulate different types of credit, but in general, lenders cannot use the following information when deciding whether to offer you credit or when deciding the rate or other terms of your credit:
- National origin
- Marital status
- Whether or not you receive public assistance.
A perfect credit score and a spotless credit report make it more likely that you’ll get the credit you apply for at a great rate, but that’s not the whole story. Lenders evaluate anything that helps them feel more confident that you have the ability to pay off your loan – metrics that indicate whether you have a steady income or cash flow, reliable job, or commitment through collateral. In addition to keeping close tabs on your credit situation, it’s a good idea to understand all the requirements a lender has before you apply for credit.