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 nine things to do as soon as your loan application is denied, in the months that follow, and before you apply again.
What to do When Your Loan Application is Rejected:
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.” In evaluating a loan application, most lenders use some variation of the five C’s of credit to judge how likely an applicant is to repay the debt. A rejected loan application means you currently fall short in at least one of these measurements:
Character. How stable are you? Do you have a good record of paying your bills? How long have you been in your current job or running your business?
Capacity. Do you have the capacity to take on additional debt? How much do you owe compared to how much you earn?
Capital. What’s your net worth, or the value of your assets minus your liabilities?
Collateral. What assets do you have that could be used to secure a loan, if necessary?
Conditions. Are there any outside circumstances that might affect your ability to repay (i.e., new government regulations affecting your industry, competition in your market)?
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 your rejection letter and tossing it into the trash, turn it into your new plan of action, so that you can be more credit-worthy down the road.
2. Address any blind spots on your credit report
Ideally, you should check your credit report three times a year, looking for inaccuracies or signs of 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.” As you browse through your credit report, it’s common to find old credit accounts that you paid off years ago, haven’t used since, and have completely forgotten about. But don’t close down those accounts just yet. The length of your history with creditors is an important factor in credit scoring, so it’s generally advisable to keep credit accounts active, even if you never plan to use them again.
3. 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.
What to do in The Months Following a Rejected Loan Application:
4. 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 greater 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.
And remember what we said earlier about not closing credit accounts after you pay them off? Maintaining zero-balance accounts increases your total amount of available credit, which keeps your credit utilization ratio nice and low.
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. Demonstrate your responsibility
Remember the “five C’s of credit”? Number one on the list was character — how trustworthy you are based on your payment history and financial stability. If your credit score was sub-par in the past due to late or missed payments, it’s time to get your act together. For at least six months following your loan rejection, commit to being flawlessly consistent with your payments. Create a calendar to keep track of the monthly due dates for all of your accounts, and set up automatic payments whenever possible, to ensure that you’re making at least the minimum payments on time. As for accounts that don’t offer automatic payments, scheduling a specific time every week to pay your bills can reduce those “did I forget to pay that?” moments that tend to plague you when you’re disorganized. Related: Procrastinator’s Guide to Bill Payment
7. Get some extra help
Low revenue and a lack of profitability can be deal-breakers when business owners apply for loans. But when you’re spending all your time working in your business instead of on your business, you lose sight of the big picture, and the overall financial health of your business suffers. One of the best ways to increase your business’s profitability is investing in outside help. For example, a professional bookkeeper can help you identify ways to trim unnecessary expenses from your operating budget as well as find outstanding invoices that haven’t been paid. (And if you need help tracking down stubborn clients, letting a small business collection agency handle the grunt-work will pay for itself and then some.) Instead of doing your own taxes, hiring an accountant at tax time will save you time, remove some stress from your life, and reveal opportunities to strengthen your finances. Pro tip: Taking every business deduction you possibly can on your tax return makes you appear less profitable, which hurts your chances at acquiring a loan. None of these options require you to hire a full-time staffer or provide employee benefits, and the positive impact they’ll have on your business will be a big asset the next time you apply for financing.
What to do When You’re Ready to Apply Again:
8. Stay away from hard credit pulls
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 of the inquiries you’re putting your credit report. Authorizing a financial institution to check your credit for a loan application typically creates a “hard inquiry” (or “hard pull”) that stays on your credit report for two years. 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. Hard inquiries are different from “soft inquiries,” which are more commonly used in background checks and pre-qualification decisions, and have no impact on your credit. While it’s always a good idea to wait as long as possible before re-applying for a loan, working with a lender like Credibly that only does soft pulls will prevent your credit score from being penalized due to frequent applications, so it’s important to find out up front if your lender will be performing a hard credit pull, a soft pull, or both. Free guide: Everything You Need to Know About Business Credit Scores
9. Come back with a better offer
Even with a substantially improved credit profile, there’s always the chance that your next application could be turned down as well, depending on the requirements of the lender. Of course, there are ways to tip the odds in your favor when you re-apply. For example…
Offering collateral: Collateral is any asset you own that can be taken by the lender if you fail to pay back the loan within the stated terms—anything from real estate and home equity to investment accounts and business machinery. (See: 25+ types of collateral you can use for secured loans.) Offering a valuable asset to back your loan in case of default gives lenders far more confidence to approve financing, and at much friendlier terms.
Making a larger down payment: Just like the down payments you would make for a home mortgage or car loan, some small business loans may also require a down payment—which means that part of the total amount you borrow immediately goes back to the lender. Offering to make a down payment beyond what’s typically required is a great incentive to offer during the loan application process (as long as the lender agrees that you can afford it).
Adding a co-signer: A co-signer makes a legal agreement to pay off your debt if you default on the loan. Co-signers could include a spouse, family member, or business partner, and they tend to great credit scores and credit history. If you ask someone to back your loan application as a co-signer, make sure they fully understand the drawbacks and risks of co-signing, including how the arrangement will impact their own debt-to-income ratio.