Personal loans are an incredible financial tool. They’re speedy, secure, convenient, and best of all, they can be used for just about anything you can think of. Consolidating debt, making improvements to your home, covering unexpected expenses, paying for a special occasion, taking a getaway vacation… the list goes on.
If you’ve been considering taking out a personal loan, here are a few tips you can use to get a rate you (and your wallet!) will appreciate. Let’s start with a brief overview of some of the personal loan requirements you’ll need to consider before applying.
What is a personal loan and how do I get one?
A personal loan is a lump sum of money you borrow from a lender and pay back in fixed monthly payments – or installments – over a given period of time.
There are a few general criteria involved in qualifying for a personal loan you should understand before submitting your application, but remember – requirements often vary from lender to lender.
If you’re hoping to qualify for a loan with a low APR, decent credit is a necessity. Generally, a credit score in the 640+ range is good enough to get you approved for a personal loan. With that said, the higher your score, the more likely you’ll be approved for loans with low rates.
Having a low debt-to-income ratio is another crucial requirement to consider when applying for a personal loan. Does your income exceed your debt? If so, by how much? The lower your debt-to-income ratio, the better the chance you have to secure a low-rate personal loan.
Finally, you’ll have to show lenders that you have the means to repay your loan. Proof of income in the form of W-2s, pay stubs, bank statements, or tax returns may be necessary for approval.
Now that you have an idea of what you’ll need to qualify, we’ll share a few tips on how you can score a better APR for your future personal loan.
What is a debt-to-income ratio and why is it important?
Your debt-to-income (DTI) ratio is a personal finance measure that compares your overall debt to your overall income. Lenders use this ratio to determine a borrower’s ability to manage monthly payments and repay the money they want to borrow from them.
When it comes to getting approved for a low-APR personal loan, the lower your debt-to-income ratio, the better. With a low DTI ratio, you’re much more likely to receive the loan amount you’re looking for at a great rate because lenders can see you’re already doing a fine job managing your current debt.
In other words, a low DTI ratio shows lenders that you don’t spend more money than you can afford to. As you can guess, a higher DTI ratio tells them quite the opposite. From a lender’s perspective, borrowers with high DTI ratios already have too much debt to manage effectively. They won’t be nearly as willing to lend to high-DTI borrowers because they’re unsure if they can handle the additional financial obligation.
Focus on lowering your DTI ratio, and your chances of receiving a better APR are much higher.
Debt-to-Income Ratio Breakdown
So – what is a good debt-to-income ratio? The Consumer Financial Protection Bureau and other experts agree on three general thresholds to consider:
Tier 1 – 36% or less: If your DTI ratio is 36% or less, you’re likely in a solid financial position and may be a good candidate for a low-APR personal loan.
Tier 2 – Less than 43%: If your DTI ratio is less than 43%, you’re probably in a comfortable financial position at the moment, but it may be time to consider ways you can reduce your debt. You may still be eligible for a personal loan, but the rates could be significantly higher.
Tier 3 – 43% or more: If your DTI ratio is higher than 43%, you may feel like your monthly payments are a bit more than you can comfortably handle. At this level, lenders may assume you have more debt than you can handle and may not approve you for new credit.
Calculating Your DTI Ratio
Knowing your debt-to-income ratio upfront ensures you won’t face any unexpected surprises when you apply for new credit. To calculate yours, simply divide your recurring monthly debt payments (mortgage, credit card minimums, loans, etc.) by your total monthly income. Take a look at the example below:
Car payment: $350
Student loan payment: $150
Mortgage payment: $1,200
Credit card minimum payment: $35
Recurring monthly debt = $1,735
Total monthly income: $4,000
DTI ratio calculation: 1735/4000 = 0.43375
Once you complete the calculation, move the decimal point two places to the right and you’ve got your DTI ratio in percentage form. In the example above, the borrower’s DTI ratio would be 43%.
How can I lower my DTI ratio?
Higher DTI ratio than you’d like? To lower your DTI ratio, you have three options: pay down your debt, increase your income, or do both at the same time. Your ratio won’t drop overnight, but if you follow the suggestions below, you could see a significant decrease in your DTI ratio before you know it.
Try these tips to begin lowering your DTI ratio:
- Pay more than your minimum on monthly debt payments
- If possible, avoid taking on more debt than you already have
- Increase your income by taking on a part-time job or finding a profitable side hustle
- Keep your budget tight and curb any unnecessary spending
While your DTI is just one measure of your financial health, it’s still an important one to pay close attention to – especially when you’re seeking out new credit.
Next, let’s walk through some credit score requirements you’ll want to consider when you’re seeking a low-APR personal loan.
What credit score do I need to get a personal loan?
Generally, the higher your credit score, the lower APR you’ll qualify for. You’ll typically want a credit score of 640 or above to qualify for a loan, but once again – requirements can vary significantly across lenders. If your credit score is lower than 640, options will likely be available, but they may come with higher interest rates than you’re aiming for.
To receive an APR that works for you and your budget, you’ll want to prioritize raising your credit score. (You can track your credit score for free in the Mint app)
How can I improve my credit score?
Improving your credit score takes time, effort, and dedication, but the benefits a high credit score can have on your financial health are remarkable.
To improve your credit score, focus on:
Making payments on time: Your payment history determines an astounding 35% of your credit score, which means making on-time payments is absolutely crucial if you’re working to raise it. A single on-time payment likely won’t improve your score by much, so you’ll have to make consistent on-time payments to see a significant increase.
Paying down credit card debt: Depending on your credit limit, carrying large balances on your credit cards could be negatively impacting your credit score. It all comes down to your credit utilization ratio, or how much credit you’re using compared to how much credit lenders have extended to you. VantageScore experts typically recommend using less than 30% of your available credit to improve your score, but the lower your utilization, the better.
Avoiding opening multiple new accounts: In general, Vantage considers borrowers who open multiple new accounts within a short timeframe to be riskier. So, if you’re applying for many different credit cards and loans at the same time, you could see a drop in your score. To combat this, it’s wise to take some time to research the options that are best for you and your needs before applying.
Note: Opening just one new account could make your score dip slightly. As long as you manage your new credit responsibly, it should bounce back quickly.
Alright, all that’s left is a brief recap to wrap things up. If you’re looking for a low-rate financial product that could get you the money you need in as little as one business day, here’s what you’ll want to keep in mind:
A high credit score is your friend: The higher your credit score, the more likely you are to be approved for a personal loan with a low APR. To qualify for a personal loan, aim for a credit score of at least 640. If you can get it higher than that, lower rates could be coming your way.
The lower your DTI ratio, the better: A low DTI ratio shows lenders you have a good handle on your debt. Aim for a DTI ratio of 36% or lower to be eligible for the best rates.
Proof of income may be required: Whether it’s a W-2 form, pay stub, bank statement, or tax return, lenders want to see proof that you’ll be able to pay them back. When it’s time to apply, it’s a good idea to have these documents ready.