Millions of Americans have the same problem – credit card debt.
Millions of Americans have found the same solution – a debt consolidation loan, which sometimes is called a personal loan.
Unfortunately, by either name, that’s not always a solution. Lenders deny a lot of applicants for a variety of reasons, leaving consumers to wonder where they went wrong and what they can do about it.
Allow us to answer both those questions, and hopefully get you started on a path to a debt-free life.
Top Reasons for Debt Consolidation Loan Rejection
A debt consolidation loan combines all your credit card debt into a single bill. It should have a lower interest rate than each of your credit cards, which means you’re paying less every month.
Consumers owed $323 billion in personal loans in 2020, according to a Credit Karma report. That was an all-time high and an $18 billion increase from 2019.
More than half of consumers with high credit card debt (more than $6,000) apply for debt consolidation loans in a typical year. A 2017 study showed that of 53 million people who applied for a loan to consolidate debt, only 20 million got one large enough to eliminate all their bills. About 21 million were rejected outright.
Why?
Low Credit Score
Lenders might not advertise it, but most of them have a minimum credit score required to get a loan. If your score is less than 670, you might be out of luck for a debt consolidation loan. Even if you’re over 670, a problematic debt-to-income ratio (more on that below) or payment history could derail your loan.
The easiest way to improve your credit score is paying bills on time and using less than 30% of the credit available on each card. It also helps to ask for higher credit limit, pay off collection accounts and avoid hard inquiries on your credit report.
But all that can take months to be reflected in your score.
You can sometimes get a loan with a shaky credit score, but it will come with a higher interest rate, which defeats the whole purpose of the loan, namely lowering your interest rate.
No Collateral
There are two kinds of loans: secured and unsecured. A secured loan requires something of value like a home, car or piece of property for the bank to “hold” as collateral in case you default on your loan. Banks like collateral. It’s like an insurance policy on your loan. If you don’t have anything to offer as collateral, your loan application may be rejected.
Insufficient Credit History
Lenders want a clue to the financial habits a potential borrower has, so they might require a minimum of two years of credit history. This includes things like credit cards, mortgage payments and auto loans. The more conscientious you are about paying those bills on time, the better your chances are of acquiring a loan. Those with no credit history will have a difficult time with lenders.
Low Income
Lenders typically look at the anticipated amount of your loan payment compared to your income, which is known as debt-to-income ratio. If the ratio for recurring monthly expenses is more that 36%, lenders will question whether you’d be able to afford payments on the loan.
Too Much Debt
Lenders are also cautious about making large loans to consolidate debt. Loaning money to someone who already owes a lot, is a substantial risk. When the whole point of applying for a consolidation loan is to create a monthly payment that would make it easier to pay off your debt, being rejected for this reason can feel especially frustrating.
So, what should you do?
Speak with a Credit Counselor to Improve Your Credit Score
Once you’ve determined the reason your loan application was rejected, you can speak with a credit counselor who will help you better understand your financial situation and what you can do to improve your credit score.
Your best bet is to find a nonprofit credit counseling agency. They offer advice on budgeting and ways to avoid problems with debt. Best of all, they do it for free.
If your debt consolidation loan was denied because you have too much debt or not enough income, create a realistic budget with a detailed plan for how you’ll use your income to help meet your goals.
To make the most significant impact on your budget and your debt, you’ll probably need to look at cutting expenses and earning extra income. Your budget can be your guide for finding places to reduce costs. With the internet and the availability of “gig” jobs, generating extra income is easier than ever.
Build a Budget and Cut All Unnecessary Spending
Having a budget is a useful tool for any responsible consumer, but it’s a must if you want to get out of debt. To make a budget, open a spreadsheet and list every source of monthly income. Then list every fixed expense you pay monthly, (like mortgage, auto loans, student loans, etc.) and variable expenses (credit cards, groceries, utility bills, gas, etc.).
Deduct the expenses from the income, and that’s the amount you can be flexible with. Flexible – but responsible. Don’t blow it on Starbucks lattes or a facelift. Use it to pay down debt or save it to build an emergency fund or fund your retirement.
Having a budget and sticking to it will inevitably improve your financial picture and impress potential lenders.
Debt Consolidation Loan Alternatives
Once you have a realistic idea how to manage your budget, you’re in a better position to look at the debt-relief options that might be open to you, including ones that don’t require getting a loan at all.
Debt Management Plan
Nonprofit credit counseling agencies like InCharge Debt Solutions work with your creditors to reduce the monthly payment, interest rate and penalties on your debt – without requiring a loan. It’s called a Debt Management Plan. You make a single monthly payment through the nonprofit credit counseling agency, which then makes payments to your creditors for you.
Home Equity
If you own your home and owe less than it is worth, you could qualify for a home equity loan to pay off debt. You can use the loan to consolidate credit card and other debt while creating one monthly payment in place of several. Bonus: you’ll likely reduce both the monthly payment and the interest rate.
Debt Settlement
You, a lawyer, or another qualified representative can negotiate with your lender for a single, lump-sum payment to settle your debt for less than what you owe. But be warned, debt settlement will cause a significant drop in your credit score and leave a stain on your credit report for seven years. It’s important to consider whether the reduced cost would be worth it.
Nonprofit Debt Settlement
This program offer the same positive – paying less than what you owe – but with a significant difference: no negotiating is involved. The lenders already have agreed to accept 50%-60% of what is owed, as long as it’s paid off in 36 months. This form of debt relief is offered by some nonprofit credit counseling agencies like InCharge Debt Solutions.
Use a Cosigner
There is strength in numbers, so consider finding someone who’ll sign on to pay the loan if you are not able to. That won’t be just anyone off the street, of course. But if you can cajole a parent or spouse or friend with a good credit history to cosign, some lenders will look more favorably on your application.
Some will, but many will not. Those lenders will only consider applicants who can meet requirements on their own, so check with prospective lenders before pursuing a cosigner.
Balance Transfer Credit Cards
Credit card companies routinely offer balance transfer credit cards with introductory deals that allow you to take existing debt from one card and apply it to a new card at 0% interest. It’s a longshot to qualify (you need a credit score of at least 670) and the 0% rate typically lasts 6-18 months. After that, you might face a hefty interest rate applied to your balance and have to find another new credit card with an whiz-bang introductory deal.
This is basically a shell game in which you move debt to a new credit card, but it can help reduce your debt if you are diligent and pay off your debt in the introductory period.
» More About: Balance Transfer vs. Personal Loan
Bankruptcy
Bankruptcy should only be used as a last resort. It will damage your credit rating and stay on your credit report for 7-10 years. And because there are substantial differences between Chapter 7 and Chapter 13 bankruptcies and complex legal procedures involved, you’ll probably need to hire an attorney.
As you work to reduce your debt, realize that you have options, even if you’ve been denied a debt consolidation loan. If you need help determining the best way forward, find a credit counselor from a reputable nonprofit counseling agency.
» More About: Debt Consolidation vs. Bankruptcy
