By Doug Matus
If you’ve ever been denied a loan or credit card, you likely wondered why. Some lenders, especially credit card companies, can be less than forthcoming about the reasons for your denial. While you can request an explanation, you will receive your answer in the form of an adverse action letter that will take about a week.
However, when it comes to your credit, a week may be too long to live with uncertainty.
If you’d like clarity sooner rather than later, consider whether these top five reasons for credit rejection apply to you.
Lenders want to see that you only use a portion of your available credit. If you consistently max-out credit cards, you appear as a financial risk. The same logic applies to loans. If you don't pay down the balances that you’ve already accrued, why should a lender take a chance on you?
“Credit scores are a lot simpler than many people think,” says Howard Dvorkin, CPA and chairman of Debt.com. “Your credit score is based on six factors, but two of them account for more than half of your score: amount owed at 30 percent, and payment history at 35 percent.”
When determining your eligibility for a loan, lenders reference your credit utilization ratio. This number represents the percentage of available credit that you’ve accessed. Ideally, you should use no more than 30 percent of your available credit. Anything more looks risky to lenders, and could explain why you had your credit rejected.
To improve your ratios, you simply need to pay down some of your debt. A tried and true tactic is the snowball approach. Pay off one balance at a time, starting with the smallest. As you have fewer payments to make each month, you’ll have more funds to dedicate to the largest debts.
If you’ve had any of these in last six months, then it makes sense that you had your application for credit rejected. A charge-off, in particular, is one of the worst things to have on your credit report. Charge-offs occur when you miss payments on a credit card balance for longer than six months.
“The very biggest factor of your credit score is on-time payments,” says Bev O’Shea of NerdWallet.com. “Paying on time is the single most important thing you can do to keep your score high. The later you were, and the more recent it was, the more it hurts your score.” See more about how late payments affect your credit score.
The two most important traits for lenders to see are consistency and reliability. Your credit report stands as a living record of your financial life, warts and all. A public record of collection will also reflect poorly on you. A serious delinquency, collections occur when a creditor determines that you will not repay your debt under normal circumstances.
There is no way to remove a public record of collection from your credit report; but as time passes, lenders will attach less weight to a failed obligation. The same applies to all payment delinquencies: if you can pay off debts that went to collection, and make on-time payments over an extended period, lenders will see that you’ve changed your ways.
If you apply for too many loans or credit cards within a short timeframe, you can expect subsequent applications to get denied.
Even if all other criteria check out, lenders hesitate to extend credit to someone who seems desperate for funds.
“One thing that can give a surprise low score is applying for several credit products at once,” says Bev O’Shea of Nerd Wallet. “A hard inquiry — one made for the purpose of deciding whether to extend credit to you — can cause a small, temporary dip. Several together cause a more significant drop.”
Sometimes, denial on a credit card application truly seems to come out of nowhere. You make payments on time, you haven’t utilized a large percentage of your available credit, and you have stable income and a good job; what gives? Unfortunately, in this scenario, you may have become a victim of identity theft.
“If you’ve been denied credit, it could be because of identity theft,” says Alex Hamilton, communications assistant with the ID Theft Center. “Often times, victims actually do find out they are a victim of identity theft because they are denied for a loan.”
If you can think of no explanation for your loan denial, check your credit report and banking statements as soon as possible. Look for any unusual items or unauthorized charges, and report them to lenders.
If you have become a victim of identity theft, you’ll also want to visit identitytheft.gov to file a claim and take restorative action.
Or consider taking a more proactive approach and getting identity theft protection. Learn more about privacy options from Consumer Affairs.
Too many negative items on a credit report will spell doom for your credit application. Too little information, however, can be just as detrimental. It can seem counter-intuitive, but if you have no history of credit use, then you will struggle to receive credit.
Specifically, FICO — the data analytics company whose algorithms generate credit scores — cannot generate a score unless you have at least one account you’ve used over the previous six months. Without any credit score to reference, a lender or credit card company cannot approve an application.
Because of this, anyone under the age of 18 is likely to get denied for a credit card. The same goes for any recent immigrant whose credit usage doesn’t translate to FICO’s records.
In the absence of a credit history, secured loans and credit cards provide a means for you to begin building a positive track record. These arrangements become secured through collateral — money you pay up front — so lenders have nothing to lose by giving you a chance. Make your monthly payments on time, and your activity gets reported to the credit bureaus. See more about establishing credit when you're 18 (or any age, really).
To stay on top of your credit, and ensure that mistakes don’t lower your scores, you’ll want to check your report on a regular basis. Thanks to the Fair Credit Reporting Act, all consumers are entitled to a free copy of their credit report once a year. To take advantage of this invaluable resource, visit www.annualcreditreport.com.
Doug Matus is a freelance writer who frequently contributes to the Self blog.