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 ...
Nov 6, 2019 · Isabelle Coetzee
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 youre an unsuitable candidate. To help you qualify for a personal loan, we had a look at what you can do today to ensure that youre loan-ready tomorrow.
But first things first: you need to understand what a personal loan is and how it works.
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.
A personal loan is classified as an unsecured loan. This means that unlike secured loans its not tied to an asset, such as a car or a house. Secured loans are considered less risky for creditors because theyre 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 youre interested in one of the latter-mentioned assets, its advisable to take out a secured loan instead.
However, if youd 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.
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 youre approved for a personal loan:
The most important factor your creditors will consider is your credit score. This is determined by your credit history with previous creditors and its 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:
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.
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 its unlikely to be a problem.
Remember, creditors are simply concerned about whether youre able to repay the debt you take on. If you can show them that you have a steady stream of income, they wont reject your application for a personal loan.
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.
Improving the above categories will take time. But if youre 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. Dont be concerned if you recently took a new job; your creditors will consider your previous long-term employment as a sign of stability.
If youre a contractor or freelancer, dont 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 youre 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 youre able to settle your open accounts.
Now that you know which steps to take in order to ensure youre 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:
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.
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.
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. Dont 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.
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