How do I get a loan? | Loans and debt | Financial Literacy | Khan Academy

Let's say that you wanted to get a loan; maybe a loan for a car or a mortgage for a house. What do you need? What do you need to think about in order to get a loan, especially a loan with a good interest rate?

Well, one of the top things that a lender will look at is your credit score. Credit score, and I'll throw history in there, although your score is really thinking about your credit history as well. And why do they care about that? Well, if I'm going to lend you money, I need to feel confident that you're going to pay that money back, and your credit score is an indication of that. But it's not the only indication.

Another thing that lender would want to see is your income level. You might have a good credit, but if you don't have an income that can be used to pay off whatever that debt is—whatever I'm lending you—then you might be a higher risk. And as I talk about in other videos, credit score and credit history does not take income level or things like employment history into account. So if I'm lending you money, above and beyond credit score, I want to see how much you're making, and I also want to look at your employment and your employment history. Are there big gaps? Are you likely to stay employed so that you can pay off this debt?

Now, another big piece—and this is related really to all of the three but especially income and employment history—is something called the debt-to-income ratio. It might sound complicated, but when you think about it, it makes a ton of sense. If you have high debt and low income, it might be harder for you to pay that loan back, but if you have low debt and high income, it might be easier.

So, for example, let's say that someone has $10,000 in debt, and they have $50,000 in income. And then another person has $20,000 in debt and $60,000 in income. If you just looked at the income, you might say, "Okay, this person has a higher income here." But then you realize they also have a lot more debt. They have twice as much debt; they have a little bit more income—they have about 20% more income—but they have 100% more debt. So here the ratio of debt to income is 1 to 5; here it is 2 to 6 or 1 to 3. So you have a higher debt-to-income ratio here, so that makes this person right over here a higher risk.

Now last but not least, this is often a very important thing, especially if you're getting a mortgage for a house or if you're getting a loan on a car. There is something called collateral, and this is not for all loans. You don't need this, for say, credit card loans. But collateral is what you secure the loan with. What does that mean?

Well, let's say that you need to borrow $100,000 to buy a house. Well, the mortgage company, the bank, will lend you that $100,000, but if you don't pay it back, they are going to take the house. In that situation, the house is what you're using to secure the debt. It is the collateral. Similarly, if you borrowed $30,000 to buy a car and if you stopped making payments or you didn't pay that debt back, then the repossession folks will come and take that car back. So that house or that car is the collateral for the debt.

Now these are the high-level things that folks will look at when you show up to get a loan. It's good to make sure you have all the information so you can fill out the forms and not have to go back and forth a bunch of times.

So, in terms of the information you're going to need, you're going to need all of your personal information. So, you know, name, contact—I'll just write personal information—and in particular a social security number. And that's going to be useful, especially for things like the credit history and for them to be able to keep track of you.

Current and past addresses—if you're seeing a theme here, they really want to see what you've been up to in the not too far future. You, of course, need some evidence of your employment history and income information. So they might want to look at a pay stub or a W-2 form—so income evidence—and usually, they'll want to see it over several pay periods. When I got a mortgage, I think they wanted to see at least two months of pay stubs when I last did it.

And then, of course, your credit score history comes from a credit report. Usually, they will run it themselves, but in certain cases, you might be able to bring it. And then there could be things like banking information, and of course, you need to tell the folks what you're getting that loan for. So I'll just call that "what's the amount and purpose of the loan?"

And it's pretty obvious if you're getting a mortgage or if you're getting a loan on a car—it's very much part of the process. But let's say you're getting a business loan. Then they're really going to scrutinize, "Hey, what type of business do you want to buy, or what type of inventory do you want to buy? And are you going to be in a position? Is that business going to be in a position to make that money back and pay down that loan?"