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Get approved for a personal loan – the ultimate cheat sheet

What you will learn in this guide:

This guide will give you a better understanding of how you can qualify for a personal loan. It will identify what a personal loan is, consider the factors that impact your eligibility, and distinguish between good and bad reasons for taking out a personal loan. 

INDEX

  • Introduction
  • What is a personal loan?
  • How to be approved for a personal loan
    • 1. Having a high credit score
    • 2. Earning a stable salary
    • 3. Lower your debt-to-income ratio
  • How long will it take to ensure approval?
  • Good reasons to take out a personal loan

INTRODUCTION

Being approved for a personal loan is a privilege, not a right. This means you will not automatically be approved for one just because you decided to apply. As such, you need to ensure you tick all the right boxes to make yourself appeal to creditors.

Some factors will improve your chances of being approved for a personal loan, while others will convince creditors you’re an unsuitable candidate. To help you qualify for a personal loan, we had a look at what you can do today to ensure that you’re loan-ready tomorrow.

But first things first: you need to understand what a personal loan is and how it works.

What is a personal loan?

A personal loan is classified as an “unsecured loan”. This means that unlike “secured loans”  it’s not tied to an asset, such as a car or a house. Secured loans are considered less risky for creditors because they’re able to take possession of its tied asset if you default on your loan. However, if you default on your personal loan, creditors may struggle to retrieve their lost funds and profit.

Because of this risk, creditors usually insist on a higher interest rate for personal loans. This means that you will ultimately pay your creditors more in the long term than you would with vehicle finance or a home loan. If you’re interested in one of the latter-mentioned assets, it’s advisable to take out a secured loan instead.

However, if you’d like to take out a loan you can use on anything, from a deposit on your new home to additional funds for home renovations, a personal loan may be right for you.

READ MORE: Check the interest before you take out a loan.

How to be approved for a personal loan

Ensuring you will be approved for a personal loan cannot be tackled as a short-term goal. It takes time to set up the right parameters and signs that will encourage your creditors to bet on you. You should consider improving the following three categories in order to ensure you’re approved for a personal loan:

1. Having a high credit score

The most important factor your creditors will consider is your credit score. This is determined by your credit history with previous creditors and it’s calculated by the credit bureaus. In South Africa, there are four of them, namely TransUnion, Compuscan, Experian, and Xpert Decision Systems (XDS).

To find out more about them and your credit score, have a look at the Ultimate guide to understanding your credit score.

Regarding your approval for a personal loan, you need to ensure your credit score is as high as possible. To do this, you should do the following:

  • Make sure you have an open account that you diligently pay off each month. If you’re able to, try to pay slightly more towards these accounts. But more importantly, you must always pay them on time – usually before the first of the next month.
  • Don’t open several new accounts in a short period of time – your credit score might take a dip if you do – but try to maintain a good payment schedule with more than one account. This will show the credit bureaus that you’re able to manage more than one debt at a time.
  • If it suits your needs, don’t hesitate to have a diversity of debt. In other words, if you only have retail accounts open, it won’t count as strongly as someone with retail accounts and vehicle finance. Creditors like to see that you can handle more than one kind of debt.

Your credit score will either propel your personal loan application, leading to more trust and lower interest rates, or it will have your application rejected. However, improving your credit score takes time. You will not see results immediately, and you must upkeep good credit behaviour for several months in order for it to have an impact.

2. Earning a stable salary

You will not be granted a personal loan unless you have a steady stream of income. So, does this mean you have to be a full-time employee? Nowadays many South Africans work as contractors or freelancers. In terms of guaranteeing a consistent paycheque, this can be tricky.

Contractors and freelancers make a living by offering their services to a variety of employers – or clients – and being paid for each of these ventures individually. This can be incredibly profitable, depending on the success of each individual, but it can also lead to “dry months”.

Sometimes contractors and freelancers struggle to pay their rent, not to mention meeting their monthly instalments on something like a personal loan. However, if you can prove to your creditor that you have long-term contracts you can rely on to cover these costs, then it’s unlikely to be a problem.

Remember, creditors are simply concerned about whether you’re able to repay the debt you take on. If you can show them that you have a steady stream of income, they won’t reject your application for a personal loan.

3. Lower your debt-to-income ratio

The percentage of your salary you spend on covering your debt expenses each month should be restricted. If you spend too much of your salary on your debt, you may struggle to meet your other financial obligations, such as paying your rent or buying food.

Therefore, creditors look at the ratio of your income you spend on your debt – otherwise known as your debt-to-income (DTI) ratio. This is calculated by dividing your total monthly debt payments by your gross monthly income and multiplying it by 100. Have a look at the below equation:

DTI = Total monthly debt payments / gross monthly income x 100

The answer to your DTI equation will be a percentage, showing you how much of your salary is spent on your debt. If this percentage is over 43%, then creditors will be hesitant to approve your personal loan application. However, if your DTI is below 36%, creditors will be more comfortable to offer you credit.

If your DTI is over 40% and a creditor decides to grant you a personal loan, it may mean that your DTI increases to 50% or 60%. This may be manageable for some lenders, but the majority will struggle to meet their debt instalments.

How long will it take to ensure approval?

Improving the above categories will take time. But if you’re willing to be a little patient and you take all the right steps, it may not take too long.

Credit bureaus need to look at a reasonable history of credit behaviour before they will improve your credit score. Make sure you check your credit report regularly so that you can pick up on any mistakes that may have slipped through. If that is the case, get in touch with the credit bureaus and resolve the matter. This may immediately raise your credit score.

Besides this, make sure your current creditors report your positive credit behaviour to the bureaus. Not all creditors will do this automatically, so speak with them to find out whether this can be arranged.

READ MORE: The value of opening an Edgars account.

In terms of a steady stream of income, being employed full-time for a reasonable period of time (at least three months, but preferably six months) will count in your favour. Don’t be concerned if you recently took a new job; your creditors will consider your previous long-term employment as a sign of stability.

If you’re a contractor or freelancer, don’t be discouraged. Try to secure long-term contracts with clients so that you can show this to your creditors as an indicator of financial stability.

You should also calculate your DTI so that you know whether you need to settle more of your current debt before you apply for a personal loan. If you’re able to settle one or two of your ongoing, small accounts, this will lower your DTI. Even lowering it slightly could be of value to new creditors, showing that you’re able to settle your open accounts.

Good reasons to take out a personal loan

Now that you know which steps to take in order to ensure you’re approved for a personal loan, you should make sure you intend to take one out for the right reasons.

Excluding emergency situations, you should aim to take out a personal loan for something that could increase your income or improve your general personal finances in the long term. The following reasons are why most people decide to take out personal loans:

  • Home renovations: This is the most popular reason why people decide to take out personal loans. Through improving their homes or renovating a garden apartment, they both increase the value of their property and create an opportunity for an additional income – the garden apartment can be rented out.
  • Consolidating debt: If you have various streams of debt you need to settle each month with high interest rates, then taking out a personal loan could reduce your overall interest payments by allowing you to settle your debt at once. However, beware of penalties for settling your accounts early. Also make sure your overall interest will go down, and that you’ll have more disposable income each month to work with.
  • Improving your credit score: Although this likely won’t be anyone’s main motivation for taking out a personal loan, it will inevitably have an impact on your credit score. If you make sure you meet your monthly instalments and pay slightly more than you need to each month, your credit score will naturally improve over time.

In addition to these reasons, you may also consider taking out a personal loan for what could be considered “somewhat good reasons”. If you intend to use it for the below list, you need to be cautious and make sure you can handle the monthly instalments – in spite of not gaining anything more than simply the loan.

  • Wedding costs: This can be notoriously high, and many couples are willing to take out personal loans to fund this, as well as their honeymoon. If you decide to go this route, try to keep the costs low and be mindful of the debt you’re starting your marriage with.
  • Business finance: Although this is often considered a good reason to take out a personal loan, and it can definitely be used for this purpose, make sure you first consider a business loan. Just like a secured loan, these may offer lower interest rates.

So what are bad reasons for taking out a personal loan? If you find yourself considering one for any of the below reasons, it may be time to reconsider.

  • Car or home finance: If you’re considering a personal loan when you really ought to take out a secured loan with lower interest rates, then you’re probably on the wrong path.
  • Vacation or grocery funding: It’s never wise to take out a personal loan for luxury or day-to-day items. If you’re struggling to make ends meet because you’re in debt, rather apply for debt counselling than a personal loan. If you’ve been dreaming of a special holiday, rather be patient and save for it. 

Taking out a personal loan is a long-term commitment, with the average borrowed amount being R35,000 and instalments being paid back over an average of 50 months. Don’t tread lightly when you decide to make this commitment.

If a personal loan is right for you, fill in this form to apply for one today.