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How Credit Factors Into Personal and Student Loan Decisions

How Credit Factors Into Personal and Student Loan Decisions

Your credit score may be the secret to a quick loan approval or the reason to blame for a high interest rate. The first thing lenders want to know when you apply for a personal or student loan is whether you can be trusted to pay the loan back.

So besides checking your income, financial health, and a few other factors, lenders will also take a peek at your credit.

Borrowers with awesome credit will:

  • Have more loans to choose from
  • Pay lower interest rates 
  • Spend less money for their loan overall

But if your credit isn’t right, you’ll be charged higher interest rates and pay more money for your loans — if you’re even approved for one at all.

Credit is a big deal to lenders.

Why Lenders Care About Your Credit

Everyone has a credit history.

This timeline includes all your current credit card debt, credit limits, outstanding loans (like a mortgage or car payment), and overdue debt reported by the government and collection agencies.

Your credit score sums up everything on your credit report in one objective three-digit number.

Lenders most often use your FICO credit score, which ranges from 300 to 850, to make their approval decisions.

Your FICO score is based on your:

  • Payment history (35%)
  • Total debt (30%)
  • Length of credit history (15%)
  • New credit accounts (10%)
  • Type of accounts (10%)

Because it includes so much, your credit score gives lenders an idea of how risky you are as a borrower. It also shows them how likely you are to repay your loan debt. 

How Credit Factors Into Personal and Student Loan Decisions 

Each of those five aspects of your credit means something crucial to lenders:

#1. Payment History Shows How Responsible You Are With Debt

Lenders want applicants with a history of paying their bills on time when they’re due. 

Late or missed payments are a huge red flag that you’re not responsible. Lenders will assume you’ll also make late payments on your loan and may get nervous.

#2. Your Total Debt Determines Whether You Can Even Afford to Take on a Loan

Lenders will not only know your income and see how much debt you have but how much of your total line of credit you’re using.

Experts typically recommend keeping your credit utilization ratio less than 30%.

So that means if you have a $10,000 total credit limit, you shouldn’t have more than $3,000 in debt.

The larger your mountain of debt, the riskier you’ll seem to lenders. They may worry about your ability to pay off your loan and all the debt you already have.

Lenders also tend to pause if your total line of credit is much higher than your income. 

If you were to go on a shopping spree and max out your credit cards during the holidays, for example, it may be impossible for you to pay off that debt and a loan on your current salary. 

Lenders do not want to be the one you can’t afford to pay back.

#3. The Average Age of Your Accounts Contributes to Your Creditworthiness 

You’ll get the average age of your accounts by adding up the ages of your oldest and newest accounts and then dividing that number by the number of accounts you have.

So for instance, if you’ve had one credit card for 10 years and another for four years, you’ll have an average credit age of seven years (10 + 4 = 14 ÷ 2 = 7).

With age comes experience and lenders know the more experience you have paying bills on time, the more likely you’ll be to make your loan payments for years to come too.

A long history of good credit behavior without any major incidents will boost your credit score and tell lenders you take your accounts seriously.

#4. New Accounts Can Either Hurt or Help You

Anytime you open a new line of credit you’ll be flagged as higher risk than someone who is not looking to take on more debt.

And each time you apply for a new account, you’ll have a “hard” inquiry on your credit. This can potentially lower your credit score by up to five points.

Additionally, a new account decreases your average account age, which counts for 15% of your credit score.

Lenders may also get sketched out if they see you’ve tried to open six new lines of credit within the last week, on top of applying for a personal or student loan. They may think you’re desperate for cash and have no real way of paying off all those accounts.

The only times new accounts have a positive impact on your credit are when you:

  • Don’t have any credit and open your first account.
  • Diversify your accounts. If you have one type of credit (such as a credit card), adding a different type (such as an auto loan) to the mix may be beneficial.
  • Lower your credit utilization ratio. If you’re using $5,000 of your $10,000 total line of credit, you’re sitting at a 50% credit utilization ratio, which is too high. 

But if you add another credit card with a $5,000 limit — and don’t make any purchases on it — your total line of credit bumps up to $15,000 and your utilization drops to just 30%, which is considered ideal.

#5. Whether You Can Manage Different Types of Credit

Lenders like borrowers with a bit of experience in all types of credit. A mix of credit card debt, car loans, mortgage payments, etc. will help convince lenders you can be trusted with their loan too.

While lenders may be able to learn all this intel about your borrowing history, what if you don’t have any credit for them to check?

What If You Don’t Have Credit?

Millions of Americans have very little to no credit. And if you’re a student, you may not have been old enough to open a credit account until recently.

But the sooner you start building credit, the better.

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Certain lenders treat zero credit the same as having bad credit because they share the same lack of healthy debt management experience.

You’ll generally need at least six months of credit history to build your credit score.

So open up a credit card, spend no more than 30% of your account limit, and determine a plan to pay off the balance before racking up too much in interest. 

While you can always apply for a personal or student loan without having credit, your chances of an approval and lower interest rates rise when you have a credit score to show off.

How to Get Better Personal and Student Loan Rates

To have your pick of loans with low interest rates and terms that fit your financial future:

Raise Your Credit Score

One of the easiest ways to qualify for better personal and student loans is to raise your credit score.

People with higher credit scores are seen as less risky to lenders because they:

  • Manage debt well
  • Pay their bills on time
  • Use less than their available credit
  • Keep accounts in good standing

Since lenders want these types of low-stress borrowers, they will offer them lower interest rates to entice them to their business.

Lower credit scores say just the opposite. 

Lenders offset the high-stress these borrowers may bring by charging them higher interest rates.

So be careful and know your credit score drops every time you:

  • Pay a bill late or miss a payment
  • Default on payments or have a charge off
  • Get sent to collections

On the FICO score scale of 300 to 850, 670 is considered good credit while anything above 800 is seen as spectacular.

To raise your credit score:

  • Monitor your credit regularly 
  • Pay your bills on time
  • Don’t max out your credit cards
  • Keep your oldest accounts in good standing
  • Don’t open several new accounts
  • Speak to creditors about lowering your debt or interest rate (or raising your credit limit to improve your credit utilization ratio)

And no matter what, always shop around and compare personal and student loans online.

Shop Around for Loans From Multiple Lenders Online

Though applicants with stellar credit may skate past the underwriting gatekeepers and qualify for lower interest rates, each lender uses different rules to determine which applicants make the cut.

One lender may save their best rates for people with credit scores above 750 while another may offer the same low interest rates to applicants with a 650 or better.

Back in the old days, you used to have to make an appointment at your bank or credit union to discuss loans. But now you can compare loan offers from multiple lenders at the same time online.

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