Personal loans can be a useful way to finance a large purchase. For example, they are commonly used when buying a car. However, in order to obtain a loan from your bank, you will need to go through an assessment process that is called credit scoring. During the application stage, the lender will ask you to provide a range of details and they will then confirm whether your application has been successful. This is an automated process and will include a live search upon your credit rating from a credit reference agency, such as Experian, Equifax, etc.
If you have previously displayed an ability to manage your finances prudently and have successfully paid off previous loans or credit cards, then this is likely to mean that you will have a higher credit score and a better chance of securing a loan. What, though, can you do if you’re fresh out of school and have no credit history?
The way that the credit score system works relies, in part, upon analysis of existing and previous banking history. Someone with no credit history is unlikely to be able to get a loan and this is particularly the case at the moment, in light of the sub-prime mortgage debacle. Banks are now tightening their lending criteria to cut down on the number of loans that end up turning into bad debt but this means that it will be increasingly difficult for school leavers to get a loan. The advice that you are likely to be offered is to wait for a few months before reapplying. The minimum amount of time that lenders tend to suggest that applicants wait is three months. In that intervening period, the bank will look at transactions on your checking account. They will want to see that you can manage your account within your overdraft credit limit and that you don’t incur any bank charges.
In addition to prudently managing your checking account, another option can be to apply for a credit card. Of course, you might run into the same difficulties in getting a credit card (as they are credit scored too) but it may prove slightly easier to get a credit card. The reason for this is that a credit card lender can restrict its risk by offering you a low starting credit limit, whereas personal loans are usually only available for amounts over $2,000. If you do get a credit card, the key again is to show that you can handle the responsibility of being given access to credit. The bank that you apply for a loan to will be able to tell if you have abused your credit card facility even if your credit card is with another company.
For most of us, the road to getting a first loan comes from this path of getting access to a checking account, then being granted an overdraft facility on it, and then getting a credit card. As we are given more and more access to credit, so our credit rating gradually starts to improve. Then, hopefully, when we come to require a loan, we will have a sufficiently strong credit rating to qualify for the funds.
If you haven’t yet had time to build up your credit rating, then you should ask yourself whether you can afford to hold off for a few months on the purchase? You may be able to put aside enough money each month to afford the purchase without the help of a loan or, alternatively, you may be much better placed to get a loan three to six months down the line.
If you absolutely must have the money now, and know that your credit score is not good enough to enable you to get a loan on your own, then an alternative option may be to get someone to co-sign on the loan with you. Where banks accept this approach, the way it works is that the money is granted on the basis that you and the loan co-signer are jointly liable on the loan. That means that if you fail to make the loan repayments, then the lender can take the funds from the person who is providing the security. You could ask a friend or family member to act as your co-signer but they will need to have a good credit rating in order for the bank to accept them as the co-signer. This is not an ideal approach as it could hurt the co-signer’s credit rating and damage your friendship if you are unable to make the loan payments.
It is undoubtedly not easy to get a loan when you’re fresh out of school but, in most cases, you shouldn’t have to wait too long before you will qualify for a loan. Remember that your bank is more likely to grant you a loan than another bank that you have no connection with. It’s also worth mentioning that it’s not a good idea to apply for loans with other banks if you’ve been declined by the first bank that you approach. The lending decisions of the other banks are likely to be the same and you can hurt your credit rating by running up multiple decline decisions.
Finally, it’s probably worth finishing with a word of caution about risk-based lending and loan sharks. Some banks have flirted with a concept called risk based lending. The idea is that you have a standard rate of interest that you offer to applicants who pass the credit score but that you may then still be prepared to offer a loan to some of the applicants who have a marginal fail. The rationale is that the higher rate is to recompense the bank for the greater risk that they are taking on in offering the loan. The chances are that this type of loan pricing will become increasingly rare in this credit crunch era but it’s worth being aware of. I would be very cautious about accepting a high interest loan, as it will make your purchase more costly and may make it harder for you to keep up payments. There are also other non-bank organisations that promote themselves as providing loans to people that the banks won’t accept. Again, in my opinion, most of these organisations are exploitative of people who have low credit ratings and it can be very dangerous to accept what are often very high interest rate loans from companies that in some cases are only loosely regulated.