Which Items Do Credit Card and Lending Companies Use to Determine Whether to Lend You Money or Not?
Have you ever wondered why one credit card application gets approved while another gets declined? Or why certain loan applications are instantly approved while others seem to take forever? The decision to lend money is not just based on a whim—it’s a thorough process. But what exactly do credit card and lending companies use to determine whether or not they’ll lend you money?
When I first started looking into applying for a credit card, I was curious about the approval process. What did I need to qualify? How could I increase my chances? After doing some research and speaking to financial advisors, I discovered there are several important factors that lenders use to make these decisions. In this blog post, I’ll walk you through the key items that credit card and lending companies use to determine whether to lend you money. Whether you’re applying for your first credit card or looking for a loan, understanding these factors can help improve your chances.
Credit Score: The Most Important Factor
Let’s start with the credit score—without a doubt, one of the most important factors lenders consider. Your credit score tells lenders how risky it is to lend you money. The higher your score, the lower the perceived risk. When I applied for my first credit card, I was nervous about my credit score. I had heard that a low score could ruin my chances, but I wasn’t entirely sure how much it would impact me.
Credit scores range from 300 to 850, with higher numbers indicating better creditworthiness. Generally, a score of 700 and above is considered good, while anything below 600 could make it harder to get approved for credit.
Lenders primarily look at the following components of your credit score:
- Payment History: Do you pay your bills on time? Late payments can have a big negative impact.
- Credit Utilization: How much of your available credit are you using? It’s recommended to keep this under 30% to maintain a good score.
- Length of Credit History: The longer your credit history, the better. A long history shows that you can manage credit well.
- New Credit: Opening too many new accounts in a short period can negatively impact your score.
- Credit Mix: A diverse mix of credit accounts (credit cards, loans, etc.) can help improve your score.
I found that improving my credit score took time, but understanding how it worked helped me focus on building a healthier credit profile.
Income and Employment History
When lenders evaluate whether to lend you money, they also want to know if you have the income to pay them back. Income is often a key factor in the approval process for both credit cards and loans. The more stable and substantial your income, the more likely you are to be approved for credit.
Here’s why: lenders want to see that you can make regular payments on the credit or loan they provide. If your income fluctuates or is too low, they may see you as a higher risk. In my experience, when I applied for a personal loan, the lender asked for documentation about my employment history and income, ensuring that I had a reliable source of income to meet my financial obligations.
You can expect to provide:
- Recent Pay Stubs or Bank Statements: To verify income.
- Tax Returns: Self-employed individuals often need to provide tax returns.
- Employment Status: Lenders want to know that you have a stable job and consistent income.
Having a steady income stream doesn’t guarantee approval, but it does increase your chances. I’ve seen cases where borrowers with excellent credit scores but unstable incomes were turned down, simply because their ability to repay was questionable.
Debt-to-Income Ratio (DTI)
Debt-to-income ratio (DTI) is another important factor that lenders examine. Your DTI ratio helps them determine how much of your income is already committed to paying off debt. It’s a critical number because it shows how much you can afford to pay toward new debt without becoming financially overburdened.
For example, if your monthly income is $5,000, and you owe $2,000 a month in debt payments (including mortgages, car loans, and credit cards), your DTI ratio would be 40%. Generally, lenders prefer a DTI ratio below 36%. When I applied for a car loan, I made sure my DTI was within a comfortable range to avoid getting turned down.
Lenders use your DTI to assess:
- How much existing debt you have: The more debt you carry, the less room you have to take on additional loans.
- Your ability to repay new debt: Lenders want to ensure that taking on new debt won’t overextend your finances.
Credit History and Length of Credit Usage
Your credit history can say a lot about how well you manage money and credit. Lenders typically prefer borrowers with a longer and more established credit history. This provides them with insight into how you’ve handled previous credit accounts. A long history of on-time payments and responsible use of credit will be seen as a good sign.
I recall when I first started using credit cards, my limited credit history meant that I didn’t have as many options. Over time, as I continued to manage my credit well, I started getting better offers. When applying for loans or new credit cards, companies can access your credit report, which contains details about:
- Your credit accounts: Credit cards, mortgages, student loans, etc.
- Your payment history: Whether you’ve been late or missed payments.
- Credit inquiries: How many times you’ve applied for credit in the past.
Collateral (For Secured Loans)
When applying for secured loans, such as an auto loan or mortgage, the lender will ask for collateral. Collateral is something of value that the lender can take if you fail to repay the loan. For example, when I bought my car, I used the vehicle itself as collateral for the loan. If I had missed payments, the lender could have repossessed the car.
With secured loans, lenders are more willing to offer money because they have a guarantee that they can recover their losses if necessary. However, for unsecured loans or credit cards, no collateral is required, but the interest rates might be higher to offset the risk.
Your Savings and Assets
Your savings and assets, such as retirement accounts, investments, and other valuable property, can also play a role in determining whether a lender will approve you for credit. When lenders see that you have assets to fall back on, they may be more likely to approve your application. This shows them that you have the resources to repay the debt, even if your income fluctuates or you encounter unexpected expenses.
I’ve found that having a healthy savings account can help improve your financial profile, and sometimes it’s the extra edge needed to get approved for a loan. It’s a great idea to keep your emergency savings intact so that you don’t face unnecessary financial pressure.
Credit Inquiries (Hard vs. Soft)
When you apply for a credit card or loan, the lender will perform a credit inquiry. There are two types of inquiries: hard inquiries and soft inquiries. A hard inquiry happens when you formally apply for credit, and it can have a temporary negative effect on your credit score. A soft inquiry doesn’t affect your credit score and typically happens when you check your credit score or receive a pre-approved offer.
In my case, I learned the hard way that applying for too many credit cards in a short period can lower your score. I recommend limiting your applications to avoid excessive hard inquiries, especially if you’re planning to make a big purchase, like a home or car loan.
Conclusion: How to Improve Your Chances of Getting Approved
To summarize, credit card and lending companies use several key factors to determine whether or not they will lend you money. The most important of these are your credit score, income, debt-to-income ratio, and credit history. Understanding these factors is crucial for improving your chances of getting approved. I’ve personally found that building a strong financial profile takes time, but once you get a solid grip on these elements, you can feel more confident about your financial future. Whether you’re applying for a credit card or looking to take out a loan, be sure to take a close look at these factors. The more you understand how they work, the better prepared you’ll be to make smart financial decisions that benefit your long-term financial health.