To put it bluntly, getting denied for an auto loan stinks. After hours of research to find the perfect vehicle and saving up for a down payment, you're ready to move forward with the purchase. You head to your bank's website to apply for a car loan, but soon your new car dreams are intercepted by the bad news - the loan wasn't approved. At this point, you have two options, wallow in self-pity while continuing to drive your unreliable junker, or take action to identify the roadblock and begin the necessary steps to remedy the situation. If you're ready to take the proactive route, we'll help you understand why the bank didn't approve your loan and what to do next.
1. Your Debt-to-Income Ratio is Too High
A high debt-to-income ratio prevents many car shoppers from getting approved for an auto loan through their bank. Some lenders have a minimum income requirement that presents a hurdle for low-income car shoppers, but income isn't the only consideration for approval. In addition to income, your expenses will also be taken into account in the form of your debt-to-income ratio. The debt-to-income ratio is defined as the percentage of your debt compared to total income. It can be calculated by dividing your recurring monthly debt by your gross monthly income. According to LendingTree, 90% of applicants approved for auto loans had a debt-to-income ratio of 48% or less.
Solutions for a High Debt-to-Income Ratio
To reduce your debt-to-income ratio, you can increase your income, decrease your debt, or both. While there may not be a quick fix for increasing your income (outside of taking on another job), there are steps you can take to reduce your debt and lower your debt-to-income ratio. First, start by looking over your budget to find potential savings that you can put towards paying down debt. Next, you'll want to pay off credit card debt and any other loans that may be increasing the ratio.
2. Lack of Credit History
Younger car shoppers, especially first time buyers, may be denied an auto loan by their bank simply because they haven't built up their credit history. Lenders don't have enough evidence that the applicant can be trusted to manage their debt and make payments on time. According to U.S. News and World Report, earning a FICO score involves having one credit account that has reported in the past six months, and one account older than six months. Without meeting these criteria, a customer won't have a credit score tied to their name.
Solutions for a Lack of Credit History
The most common solution for getting approved for a car loan with no credit history is to enlist a cosigner like a parent or other close relative. Other options to build credit include becoming an authorized user on a family member's credit account, getting rent payments reported to the credit bureaus, or getting a credit builder loan.
3. Derogatory Credit
A low credit score due to multiple vehicle repossessions, bankruptcy, or foreclosure is a major red flag for banks when they evaluate car loan applications. Some lenders have a minimum credit requirement that they may not disclose which makes it difficult to predict your odds of approval. Luckily, there is more transparency after the application is declined in the form of an adverse action letter. An adverse action letter explains why your auto loan was denied and provides instructions to obtain a free copy of your credit report so you can determine the best course of action.
Solutions for Derogatory Credit
Once you obtain a copy of your credit report, look over it closely and check for any errors that might be bringing down your score. Correcting these errors will be one of the quickest ways to boost your credit score and improve your shot at car loan approval. Just like a cosigner can help car shoppers with no credit history get approved, shoppers with compromised credit should also consider asking a relative or close friend to cosign on the loan. Lastly, looking for auto loan options outside traditional banks will increase the chances of approval. Alternative lender options for car shoppers with bad credit include credit unions, Buy-Here-Pay-Here dealerships, and online lenders that specialize in subprime credit.