Having your loan application rejected is a wake-up call that your credit or business health isn’t as strong as you thought (or hoped) it was. It can be a very demoralizing experience—especially if you were counting on that financing to sustain your business operations.
When a loan application is denied, it can usually be traced back to two explanations: bad credit or a high debt-to-income ratio. Fortunately, both of those things can be fixed with responsible practices and a little patience, making you more likely to get a “yes” the next time. Here are 6 things to do as soon as your loan application is denied.
1. Study your rejection letter
All lenders are required by law to send you a written notice confirming whether your application was accepted or rejected, as well as the reasons why you were turned down for the loan. According to the FTC:
“The creditor must tell you the specific reason for the rejection or that you are entitled to learn the reason if you ask within 60 days. An acceptable reason might be: ‘your income was too low’ or ‘you haven’t been employed long enough.’ An unacceptable reason might be ‘you didn’t meet our minimum standards.’ That information isn’t specific enough.”
Understanding the “why” of your rejection helps you know where to focus your efforts, whether that means paying down your existing debt or building more credit history. So, instead of balling up the letter and tossing it into the trash, turn your rejection letter into your new plan of action so that you can be more credit-worthy down the road.
Related: How Does Business Credit Affect Lending Decisions?
2. Address any blind spots on your credit report
Ideally, you should check your credit report three times a year, looking for old accounts that should be closed or inaccuracies which could suggest identity theft. But with so much on your plate as a business owner, keeping up with your credit can sometimes fall by the wayside.
That becomes a real problem when your loan is rejected for reasons that take you by surprise. Credit reports don’t just summarize your active credit accounts and payment history; they also collect public record information like bankruptcy filings, foreclosures, tax liens, and financial judgments. If any of those things are misrepresented on your credit report, it can be tremendously damaging to your chances of securing credit.
Whether inaccuracies occur due to malicious act or accident, it’s ultimately up to you to stay on top of your own credit. Access your credit report for free on AnnualCreditReport.com, and file a dispute with the relevant credit bureau (either Experian, Equifax and TransUnion) if you see anything shady on the report they provide. As credit.com advises:
“If you see any accounts you don’t recognize or late payments you think were on time, highlight them. You’ll need to dispute each of those separately with the credit bureau who issued that report. Even if the same error appears on all three of your credit reports, you’ll need to file three separate disputes over the item.”
3. Pay down outstanding balances
One of the most common reasons for loan rejection is credit utilization—the ratio of your current credit balances to credit limits. This is slightly different than your debt-to-income ratio, which divides your monthly debt obligations by your monthly gross income. Both measurements reflect how much additional debt you can afford to take on, so the lower these ratios are, the better chance you have of being approved for a loan.
Being denied for a loan due to your credit utilization or debt-to-income ratio means that lenders aren’t fully confident that you’ll be able to make your minimum payments. There’s nothing to do here except take your medicine: put your new financing plans on hold and focus on paying down your balances until your debt-to-income ratio is below 36.
4. Beware of desperate measures
If you applied for a loan to stave off financial hardship, being turned down can create panic that can lead to some very bad choices. Predatory lenders make their living on that kind of panic, and their risky, high-interest loans almost always leave you worse off than before.
Predatory lenders offer financing that is intentionally difficult to repay. Through their extremely high interest rates, unreasonable terms, and deceptive practices, these lenders force desperate borrowers into a “debt cycle,” in which borrowers are trapped in a loan due to ongoing late fees and penalties. Two of the most common predatory loans are:
Payday loans: These are short-term loans with interest rates typically starting at 390%. (No, that’s not a typo.) A borrower provides the lender with a post-dated check for the amount of the loan plus interest and fees, and the lender cashes the check on that date. If the borrower doesn’t have enough money to repay, additional fees and interest are added to the debt.
Title loans: The borrower provides the title to their vehicle in exchange for a cash loan for a fraction of what the vehicle is worth. If the borrower is unable to repay, the lender takes ownership of the vehicle and sells it.
Please don’t go this route. If your loan rejection has left you desperate for money, swallow your pride and try to borrow from friends and family instead.
5. For thin credit, start small
Being turned down for an “insufficient credit file” doesn’t mean you’re irresponsible—it simply means you don’t have a long enough history of credit maintenance and payments for a lender to make a confident decision about your creditworthiness.
While this situation is very rare for established business owners (who generally have years of credit card and vendor account payments under their belts), young entrepreneurs might not have a long enough credit history to secure the financing they need. If that’s the case, you’ll have to go through the motions for a while: Opening a couple of small credit accounts with easy-to-manage payments will prove to lenders that you have your finances under control.
The Consumer Financial Protection Bureau recommends two low-risk options to build up your credit file: Secured credit cards, in which you put down a cash deposit and the bank provides you with a credit line matching that amount, and credit builder loans, in which a financial institution deposits a small amount of money into a locked savings amount, and you make small payments until you come to the end of the loan term and receive the accumulated money.
6. Wait for the right moment
When you authorize a financial institution to check your credit for a loan application, it typically creates a “hard inquiry” (or “hard pull”) that stays on your credit report for two years. This is different from a “soft inquiry,” which is more commonly used in background checks and pre-qualification decisions, and has no impact on your credit. (Some alternative lenders only use soft inquiries during your application and funding process, so it’s important to find out up front if your lender will be performing a hard credit pull, a soft pull, or both.)
Each hard inquiry won’t affect your credit score much on its own, but multiple hard inquiries in a short period of time can be a major red flag for lenders, who may interpret those inquiries as a sign of financial instability or desperation.
When you’re turned down for a loan, your first instinct might be to immediately apply for a loan elsewhere, in order to get a “second opinion.” The problem is, you may be even less likely to be approved for that next application because you’re racking up hard inquiries on your credit report.
Our advice? Don’t apply for another loan until you’ve made significant improvements to your credit and financial health—a process that can take a year or more. The longer you can wait, the better.
Free guide: Everything You Need to Know About Business Credit Scores