It’s bound to happen to all of us at one time or another – you go to apply for a new credit card (or an auto loan, mortgage or any other line of credit) and, out of nowhere, they turn you down.
You’re shocked. Angry. And – if you know that you have a fairly good credit score –flabbergasted.
But I have good credit, you shout. How can you reject my application?
After a number of emails from readers who were declined on credit card applications despite credit scores in the high 600s to 700s, I thought I’d write this post.
After years managing my own credit and interviewing experts for this blog, I’ve got a few insights.
A good credit score isn’t everything
If you are a regular reader of this blog or others like it, you probably have a (healthy) obsession with your finances – including your credit health. You check your credit reports at least once a year and perhaps use a free monitoring tool to track your credit score.
We’ve been taught to get this number into the 700s or beyond so that we always qualify for the best interest rates.
Although it’s true that it’s important to have a good credit score, your score is just one of many factors a bank will use in deciding to extend you credit.
Creditors like credit card and mortgage companies pay companies like Fair Issac (FICO) and Experian (one of the main credit bureaus) big bucks for access to their credit score data because it simplifies the myriad calculations the bank must make to assess whether you’re a good credit risk or not.
Rather than pulling every record on your credit report and running their own calculus of how many timely payments you’ve had, how long you’ve had credit, and what you owe on your debts – banks like Chase or American Express pay the credit bureaus to grab that data in one useful score.
But that’s the beginning of the credit decision, not the end.
Understanding the underwriting process
When you apply for credit, whether it’s a credit card with a $3,000 limit or a mortgage for a $300,000 home, your application begins the process called underwriting.
Underwriting is how the bank decides whether to take on the risk of lending you money. Parts of the underwriting process are to comply with laws governing how the bank can lend money, and other parts are to protect the banks’ own interests and ensure the loan is profitable. Banks would be out of business (and our economy in trouble) rather quickly if they loaned too much money that they couldn’t collect.
In some ways, the stakes for a credit card application are lower than on a big mortgage. The bank puts a lot less money on the line.
But in one respect, credit cards are actually risky for banks. That’s because a credit card is an unsecured debt. A mortgage, on the other hand, is secured. If you don’t pay, the bank can foreclose and take possession of an asset (your house). If you don’t pay your credit card bill, the bank can send collectors all day long and even sue you, but they can’t come in and take property to cover their loss.
Every bank – even every credit card – has different underwriting criteria. This is why you can get approved for some credit cards with a lower credit score, but be turned down for others.
A bank’s actual underwriting is a trade secret, but we know generally what they look for.
No recent late payments or collections activity.
Missing a single credit card payment or forgetting about a medical bill that ultimately ends up going to collections isn’t the end of the world. Such a slip might reduce your credit score by 10 or 20 points for a year or two, but it won’t take you from 750 to 500 overnight.
It might, however, prevent you from getting new credit. If you have “potentially negative items” on your credit report like late payments or collections accounts, this could cause you to be denied a new credit card.
A low debt utilization ratio.
Your debt utilization ratio is the total of your monthly outstanding credit card balances divided by your total credit limit.
Your utilization ratio is calculated using your statement balances – even if you pay the card in full each month.
Lower is better. If your ratio is 50 percent or higher it will definitely raise flags in underwriting because it is a common predictor of people who are close to “maxing out” their credit cards.
So if you just have one credit card with a $3,000 limit and regularly spend $2,000, watch out – your utilization ratio is in the danger zone even though you don’t carry over your balance. To solve this, you can pay your credit card balance down before the billing cycle ends.
Adequate employment and income.
Banks look at your likelihood of repaying a loan based on past behavior (your credit score) and also your ability to repay the loan now (based on income). You’ll be asked to list your annual income and employer. For a larger loan, the bank will verify this data. They may not for a credit card, but don’t expect to be approved for a $10,000 limit card if your annual income is only $20,000.
A long credit history.
This is where, despite your best efforts to build good credit, being young works against you. The longer you have been making timely monthly payments on loans and credit cards, the more banks trust that you’re creditworthy.
Building this track record takes years. Your credit age is determined not only by when you opened your first credit account but the average age of all your credit accounts. So whenever you get a new loan or credit card, it reduces the average age of your credit lines.
Although there’s not much you can do about this one except make your timely payments and wait, it’s a reminder that this could be a reason you’re declined on a credit application despite having a good credit score.
No “credit hungry” behavior.
Someone who is eager for more credit – what I describe as being credit hungry – will likely apply for any credit card offer they see. Each time you apply for credit, it creates what’s called a hard inquiry or “hard pull” on your credit report.
Credit bureaus typically look back at the last two years and begin to dock points off your credit score if you have more than one or two hard inquiries. If you have more than a few – especially in the span of just a few months – it indicates you’re credit hungry and is a common reason your credit card application might be denied.
Now some people do this to exploit signup bonuses and wrack up tons of frequent flyer miles, but most people who are credit hungry are applying because their financial life is a mess and they need credit to stay afloat.
That wraps up some common reasons you might be declined for a new credit card even though you’ve got good credit. It’s frustrating, but a credit app decline isn’t the end of the world. After you’re declined, you’ll get a letter or an email stating some vague reasons your application was rejected. These can seem cryptic, but hopefully this article sheds some light on what the bank was thinking so you can continue to improve your credit and have better luck next time.