Why do Lenders Check Credit Before Approving Loan Applications?

- by Sarah Connelly

Why does my credit matter when I take a payday loan? Read the ins and outs of credit and payday loans and what lenders look at when approving loan applications.

Taking out a loan can be a pretty intimidating prospect. No matter your financial position there are always going to be risks and fears involved when you take out any loan, no matter what size it is. Whether it’s the fear of being unable to make repayments, to the tension over interest rates, there are dozens of things that can make taking out an online loan a deeply stressful experience.

Are credit checks needed for approving loan applications - cashfloat

What Does a Bad Credit Score Mean?

That being said there is one thing that causes a lot of people more stress than just about anything else. This is the idea of having their loan application rejected. After all, it hardly takes a genius to realise that, if you’re taking out an instalment loan, it’s probably for something relatively significant. Very few people take on the risks and pressures that a loan produces unless it’s something that they genuinely need. This is why homes and cars are some of the most common things that are bought using a loan. It’s tough to get through life without these things. This means that a rejected loan application can put you into a pretty serious dilemma.

There are several reasons why a lender might reject your loan application. Perhaps you don’t have the money to make an initial down payment, or you might simply not have a high enough income to justify the repayments that you would have to make. But there is one thing that many people find to be the biggest hurdle between them and a loan that they need. The credit check.

My Credit Score

The credit check is something that many people view with utter dread, despite not being entirely sure what it actually entails. Most reputable lenders are going to conduct a thorough credit check before approving loan applications to establish whether or not you’re eligible for a loan.

Are credit checks needed for approving loan applications - cashfloat

Despite being so important, it’s remarkable just how little the vast majority of consumers actually know about why lenders conduct credit checks before approving loan applications. Not many know what it even entails, and what impact it can have on your ability to secure any form of loan. To make that all a little clearer, here are a few of the reasons why lenders perform a credit check before approving loan applications.

1. A Credit Check is Recommended by the FCA

Any organisation that offers credit of any kind in the UK is recommended by the Financial Conduct Authority (FCA) to carry out a credit check. This recommendation is to protect customers at every stage of the borrowing and lending process. If lenders were to go around approving loan applications without conducting a clear and thorough credit check, that significantly increases the chance of them approving a loan to someone in serious debt. This person is unlikely to be able to afford the necessary repayments on their loan, and this is going to result in increased financial difficulty for them and a deficit for the lender.

Are credit checks needed for approving loan applications - cashfloat

The FCA also ensures that lenders offer total transparency to consumers. Brokers must also make it explicitly clear that they are not lenders. The FCA even provides a Consumer Credit Register that will help you to find out the contact details and trading names of a consumer credit firm. You can also see what level of authorisation they have to offer consumer credit.

2. Payday Loan Eligibility

Credit checks are yet another method through which lenders figure out if you’re eligible for a loan. There are plenty of different factors that impact your credit score.

A few things that impact your credit score:

  1. Registering to vote – How you vote makes no difference to your credit rating but being registered to vote in the first place does.

  2. Repayments – If a lender can see that you are reliably keeping on top of your repayments, then you’re in a much better position to get a decent credit score. Therefore, lenders are more likely to be approving loan applications from you.

  3. Income – Keeping a regular income as much as you possibly can is a great way to increase your credit score. No matter what you actually take home at the end of each month, if your contracted salary isn’t high enough, it can be very difficult to convince lenders that you’re a reliable borrower.

Many of these factors are going to be more significant than others, and you should remember that each lender has their own methods of assessing your credit score. Just because you’ve been rejected by one lender, it doesn’t mean that every lender will do the same.

Are credit checks needed for approving loan applications - cashfloat

3. Short Term Loan Risks

Every loan represents a risk, both to you and to the lender. In the same way that you do, lenders want to do everything that they can do reduce the risks involved in offering loans to people. This means that there are certain things on a credit report that act as pretty significant red flags for lenders. These things often act as signs of whether or not someone is a reliable enough borrower to justify the risk of lending out money.

Red flags on your credit report:
  1. Multiple lines of credit

    It isn’t especially likely that any lender or credit provider is going to be particularly shocked at the sign of a credit card on your credit report. If, however, they see that you’ve set up multiple new cards in a short space of time then that’s probably going to become a cause for concern. Multiple new credit cards or loans being taken out within a short period is often an indicator that something bad is going on with your finances. Multiple lines of credit are a sure sign to many lenders that you’re not going to be financially reliable enough to justify the loan that they’re offering.

  2. Are credit checks needed for approving loan applications - cashfloat
  3. Other people’s debt

    This is something that many people don’t realise. When you co-sign to help someone else take out a loan or apply for a credit card, that debt ends up on your credit report. All of it. Now, this isn’t necessarily a bad thing since you probably aren’t going to co-sign with someone who doesn’t intend on making their repayments regularly and on time. But, it does mean that it’s an extra piece of debt that lenders are going to have to take note of.

  4. Minimum payments

    Lenders often don’t like to see that you’re only paying the bare minimum on any existing debts. It shows that you’re not necessarily in the right financial position to take on any more debt and that you might well be struggling financially already. Consistent minimum payments is a sign to many lenders that you’re simply not in a position to pay off the entire amount.

4. Loan Interest Rates

Many lenders offer a particular interest rate when they’re advertising, but that’s not actually the interest rate that they have to provide. This is their “representative APR” and they only actually have to offer it to 51% of customers. If your interest rate is higher, then there’s a chance that it’s because of your credit rating. The benefit of this is obviously that if your credit score is less than ideal, that doesn’t mean that the lender will definitely reject your application. It may simply be a matter of paying a higher than average interest rate on whatever you borrow. This might seem like a great solution, but remember that this is something set up by the lender to protect themselves. It’s not really for your benefit.

Conclusion on why Lenders Check Credit Before Approving Loan Applications

Interest rates are a major concern for many consumers when it comes to taking out a loan or buying anything on credit. Often, the interest rates alone are enough to discourage some people from borrowing any money in the first place. This is a big part of the reason why UK payday loans are often eyed with such suspicion since many of them come with APR percentage that’s in the hundreds, if not thousands. Mortgage loans and credit cards often come with far, far lower interest rates. Still, be aware that they can still fluctuate a great deal.

More importantly, make sure that you can actually pay the entire amount including the interest! Far too many people think only about the amount that they’re borrowing when working out if they can afford the loan. Of course, once again, every lender is different. They will each have different criteria for how your credit score impacts on the interest rates that they will charge. Still, every responsible lender is recommended to perform a check credit before approving loan applications, so don’t fall for ‘no credit check loans’ adverts!

Are credit checks needed for approving loan applications - cashfloat

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About The Author
Sarah Connelly
Sarah is a dynamic writer and blogger with a keen interest in digital marketing. After completing her degree in Computer Science, Sarah realized her need for a creative outlet, leading her to blend her technical skills with content creation at Cashfloat.
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Warning: Late repayment can cause you serious money problems. For help, go to moneyhelper.org.uk