Due to the pandemic, a large number of people have faced a huge financial crisis, especially during the lockdown. However, even after the lockdown has been lifted, things are far from getting back to normal, financially.
In the course of this time, there are people still under a cash crunch and finding it hard to keep up with their day-to-day lives. Hence, people are looking at taking loans to help them during this crisis. You need to have a good credit score to get a loan approved.
Having a good credit score that is 750 or higher will give you access to a broader array of lenders and better interest rates. When applying for a loan, or any other type of credit, a good credit score can mean a greater range of choice for the borrower in terms of lenders and loan offers, and attractive interest rates and fees.
Credit scores represent the borrower’s history with credit as recorded in his/her credit reports. This credit report helps lenders understand how experienced and responsible the borrower is in handling debt. Having a higher credit score relates to having lower chances of failing to repay debts. Therefore, lenders consider it riskier to lend money to borrowers with lower credit scores than to those with high scores. Lenders usually charge more from borrowers with lower scores to offset their greater chances of loan default, and typically offer their best deals on loans and credit (low-interest rates and fees) to borrowers with high credit scores. If an applicant’s credit score is too low, banks and financial institutes might not even offer them credit at all.
Having said that, there are multiple cases when a borrower’s loan application gets rejected even with a good credit score. As mentioned earlier, the credit score indicates how the borrower’s earlier loans were serviced. However, it doesn’t say anything about the borrower’s ability to service more loans.
Banks and financial institutions also look at the applicant’s ability to pay off additional debt, if he/she wishes to take on more besides a good credit score. The banks and financial institutes check on the borrowers while evaluating their financial fitness. This is where most people fail to get a loan even after having a good credit score – other ongoing loans/debts. For instance, if you have other loans that you are repaying, such as personal loans, car loans, education loans, home loans, etc. you could get rejected. That’s because banks or financial lenders usually see the debt-to-income ratio (DTI) of a borrower to measure his/her ability to manage debt repayments. DTI ratio is best calculated on a monthly basis, and having a low DTI shows that the applicant has a good balance between debt and income.
For instance, if your monthly income is Rs 50,000 and you are already paying around Rs 25,000 towards your ongoing loans, credit card dues, etc. there is a high chance that your application could get rejected. The lenders take the total monthly debt obligations of an individual, which includes minimum credit card dues, car loans, education loans, home loans, etc. and divides it by the net monthly income of that individual. This shows the lenders how much additional debt the individual’s financial situation will allow him/her to handle.
Experts suggest in the long run, the borrower can reduce the overall debt burden by paying off the dues with any extra cash flow. This will improve the borrowing power of the borrower in the future and he/she will have better control of their financial situation, especially during a financial crisis.