One attribute that subprime borrowers share is risk that translates to fees and rates the way they are. While there are no hard-and-fast rules when it comes to lending decisions, mitigating the risk that you represent to the lender can be done.
A good place to start is these areas that lenders normally look at and into when they assess your creditworthiness, building on the five C’s of credit.
- Character: Credit Score and History
- Capacity: Income and Employment
- Capital: Assets and Investments
- Collateral: Loan Security and Pledge
- Conditions: Loan Term and Down Payment
Improve your chances of getting a loan.
Credit Score and History
Character can be referred to as credit history that if summarized is your credit score. To a lender, a good credit score demonstrates a responsible use and management of debts over time. This makes you less likely to default on your loan, thus less risky on their books.
If your credit score meets their standards, they’d likely not poke their heads further into your credit history. A low credit score alerts lenders that something negative may have happened in the past that leads to more questions from them, The usual red flags are bankruptcy, foreclosure, unpaid collections bills, high level of debt and so on.
Income and Employment
The ability-to-repay rule just banks on the standard income verification that lenders employ. Usually, you are considered a less risky candidate if you make a good income. The catch is your housing costs should not be too high.
There is the debt-to-income ratio which measures how much you earn versus how much you owe. An acceptable level is 43% or less of your monthly gross income should go to your housing-related expenses.
With steady income comes a steady employment. While lenders don’t really require that you stay put in your position for a long time, they would likely you see as less risky if you have shown a stable employment history.
Assets and Investments
You fit the bill of a less risky borrower if you have assets to support monthly loan payments in case you lose your job, experience a drop in salary or other adverse financial events.
These assets can be in the form of savings, certificates of deposit, bonds, and money market funds that are redeemable on demand and easily converted to cash when the need arises.
Loan Security and Pledge
A collateral is the asset that secures your promise to pay back your debt. The collateral, most often than not, is the asset subject of the loan, e.g. home for mortgages and cars for auto loans. In the case of personal loans, you may be required to put forward an asset with substantial value to secure your loan repayment.
Secured loans or those with collateral have lower rates compared to those without any. Needless to say, your collateral should have adequate value to demonstrate less risk to the lenders should you stop paying back your loan.
Loan Term and Down Payment
Having a loan with a longer term is more risky to the lender because the sheer length increases the chances of default. That’s why 15-year mortgages, for example, fetch lower rates compared to their 30-year counterparts. To balance things out, a shorter-term loan has higher monthly payments compared to a longer-term loan.
Another factor that contributes to the risk is the loan size. The bigger your loan amount, the higher risk it represents. This risk can be compensated by putting a large down payment. This invariably lowers the amount you need to borrow and your rate too.