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Underwrite Yourself for a Loan

Bank in Vermont

Have you ever wondered how bankers decide whether or not to approve a loan?  Have you ever been rejected for a loan?  Are you interested in a new loan sometime in the near future?  If so, you should probably know a bit about how bankers underwrite loans to decide whether to approve or deny prospective customers.

Get Your Free Credit Report

To start, print out a copy of your annual credit report that you got for free from annualcreditreport.com.  I am a fan of going paperless, but the bankers really do print your credit report out in full for review.  I did when I was working in a bank, and that is what we were all taught to do.

Remember that your credit score is more of a screener than an approval tool.  If your score is really bad, you will be screened out right away.  If it fair or good, you will go through the process below.

Once you have your credit report in front of you, start at the top and cross out any credit account that says “authorized user” next to it.  Those are generally accounts that someone else is a primary user for.  The bank assumes that you do not pay for those.

Look for Late Payments

Next, go back to the top of the report and highlight any late payments.  The report usually makes it easy to find those in your payment history.  Look for a grid with stars representing on-time payments and 30, 60, 90, etc representing the number of days late.  This is what my report looks like, as I have no late payments.

If you have any late payments, highlight them with a bright pink highlighter or circle it with a red pen to denote it as bad.  If all payments on the account were on time, put a check mark next to it.  Make sure every account is either crossed out (authorized user), checked off (on time only), or marked for late payments.

Look at Account Balances

Next you need to look at balances.  Look through your accounts and circle any account balances with a black or blue pen or highlight it with a color that is not what you used for the “bad” items.  Make sure every balance is highlighted.  For revolving credit accounts, such as a credit card, highlight the credit line amount as well.  Add up all of your balances and credit limits separately and write them at the bottom of the report.  The account below has a balance of $299 and a limit of $2500.  Look for something like that as an example.

Next, go through and highlight all of the minimum payments on your installment loans, such as a car loan, mortgage, or any loan with a fixed payment and end date.  Add those up and write that number at the bottom as well.

Calculate Your Credit Utilization

Now, divide your outstanding credit card balances into your credit limits.  This gives you a utilization percentage.  In the $299/$2500 example above, you would have an 11.9% utilization rate, which is acceptable by most banks.  Any number over 25% might hurt your chances on the loan.  Anything over 75% will almost certainly disqualify you.  If your total outstanding revolving balance is over $10,000, you will probably have a tough time getting a loan as well.

Now, multiply your outstanding revolving balances by .1 to give you 10% of your balance.  For example, 10% of $299 is $29.90, or about $30.  That is what most banks will assign you as a minimum monthly payment.  Add that to your installment minimum payment, and you will have a total debt servicing payment amount.  If you have $300 in revolving balances and a car loan that requires a $220 monthly payment, your debt servicing payment is $250 per month.

Calculate Your Debt to Income Ratio

Now write down your monthly regular income.  You can include child support, alimony, or social security. if you receive payments.  Subtract your monthly rent or mortgage payment and fixed expenses from that number.  Next, divide your debt servicing number by your income after fixed expenses.  That gives you a debt servicing ratio.  If you have a $250 payment and your income after fixed expenses is $2000 per month, your ratio is .125.  Any number below .1 is great.  Many banks would consider any number below .3 acceptable.  Over .5, you probably will not get the loan.

Now look at the whole picture.  Past performance is the best prediction of future performance.  If you have a lot of late payments, you will probably have trouble getting a loan.  If you have high balances on your credit cards, you will have a tough time getting a loan.  If you are using 90% of your available credit, most banks will not give you more.  Any one issue might be looked over, but the big picture is what will get you.

I Know It's Complicated

If you have any questions, please let me know in the comments. I am happy to answer your questions if you get stuck underwriting yourself for a loan. Also, check out how to get a real, 100% free credit score.

Originally posted August 13, 2009. Updated June 17, 2013. Image by NNECAPA / flickr.

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