When applying for a loan, a common concern is how a declined loan affects your credit score. Does loan rejection affect your CIBIL score, or does the loan application itself pose a risk to your credit score? 

A loan rejection itself doesn’t directly affect your credit score, but the process leading to it can. When you apply for a loan, the lender typically conducts a hard inquiry on your credit report. While this inquiry is recorded on your report, a single hard inquiry usually has a minor impact on your credit score (typically a few points).

To understand why loan rejections happen, you need to know the basic steps of loan processing:

1. You select a lender and submit the application form at a branch or online 

2. The bank will review your credit history, score, and other details 

3. Your loan is either approved or rejected

The impact of rejection depends on the type of inquiry created. Your credit report contains soft inquiries and hard inquiries. Soft inquiries occur when you check your own report. It will not affect your score. 

A loan rejection does not directly affect your credit score, since lenders do not report approval or rejection outcomes. What impacts the score is the hard inquiry raised when you apply for credit, which can lower your score slightly. 

However, if you make too many applications in a short time, multiple hard inquiries may signal you as credit-hungry. It can indirectly make it harder to get future approvals, even though the rejection itself is not reflected in your credit history.  

Applying for a loan is a major milestone in your financial journey. Understanding the common reasons for loan rejection can help you better prepare and improve your chances of approval. Here are some possible reasons for your loan application rejection: 

1.Low CIBIL Score

A low CIBIL score from missed payments, high credit utilisation, or repayment defaults signals high risk and may result in loan rejection. Your CIBIL score reflects your creditworthiness based on your financial history. Lenders thoroughly assess your credit report to establish your financial standing.

2.High Debt-to-Income Ratio (DTI)

Your DTI ratio measures the percentage of your monthly income allocated to debt repayments. A high DTI shows that a large share of your earnings goes toward existing debts. It can be concerning for lenders due to your lowered repayment capability.

3.Unstable Employment History

Your employment history provides lenders with assurance about your ability to repay the loan. It demonstrates that you have a stable source of income. 

Frequent job changes or employment gaps can raise concerns about your stability. It may affect your repayment capability, potentially leading to a rejection of your application.

4.Insufficient Income

Even if you have a good CIBIL score, lenders can still reject your application if your monthly income does not meet the minimum requirement. Lenders assess your income to ensure you can manage loan repayments alongside your other financial obligations. 

5.Multiple Loan Applications

Submitting several loan applications within a short time frame can result in multiple hard inquiries on your credit report. This can lower your CIBIL score and give lenders the impression that you are in financial distress. This can make them hesitant to approve your loan application.

6.Incomplete or Inaccurate Application

Providing an incomplete or inaccurate loan application can result in immediate rejection. Lenders require accurate details to assess your eligibility, and any discrepancies can lead to distrust.

7.Purpose of the Loan

Some lenders have restrictions on how you can use the loan funds. If your intended use does not align with the lender’s policies, they might decline your application. Ensure that your loan purpose matches the lender’s acceptable use cases. 

8.Lack of Credit History

A limited or non-existent credit history can make it difficult for lenders to assess your creditworthiness. Without a track record of managing credit, lenders may be reluctant to approve your loan application. 

9.Age and Citizenship

Lenders have specific eligibility criteria regarding your age and citizenship status. Not meeting these criteria can result in clear rejection. Make sure you meet the lender’s basic eligibility requirements before applying. 

The following strategies improve your eligibility and help you secure your credit score and approval for a loan:

• Check Eligibility Before Applying

Every lender has requirements for loan applicants that you need to meet. These requirements involve age, income, citizenship, etc. Not meeting these criteria is one of the primary reasons for rejection. You can select a loan provider where your eligibility aligns with the requirements. 

• Avoid Multiple Applications in a Short Time

Applying for multiple loans at the same time may indicate financial struggle to lenders. It is important to first clear your existing debts to strengthen your repayment capacity and improve your chances without harming your scores. 

• Apply With Lenders Suited to Your Profile

Choose lenders whose eligibility and documentation requirements match your credit profile. This will help you apply without compromising and reduce unnecessary rejections. 

• Review the Credit Report in Advance

Existing debts and errors in your profile can leave a negative impact. Check your credit report before applying to identify these errors or pending issues. This way, you can address problems early and present a flawless profile to the lenders. 

• Improve Your Credit Score First

Work on increasing your credit score by repaying debts and maintaining timely payments. You can also work on lowering your utilisation ratio and retaining older credit card accounts. A higher score can improve your eligibility, credit score, and allow access to better loan terms. 

• Provide Complete and Accurate Documentation

Verify every entry for accuracy and completeness before you submit the application. Any error or discrepancy can result in immediate rejection.

• Consider Pre-qualified Offers

A lender gives a pre-qualified loan offer when you meet basic criteria like age, income, and liabilities. It is only a preliminary offer, as the final sanction depends on a detailed eligibility and credit check. 

Having your loan application rejected can be disheartening, but it is an opportunity to enhance your credit profile. Here are steps you can take to improve your credit score and boost your creditworthiness: 

• Understand the Reason for Rejection

Contact the lender to understand the reason behind your loan rejection. Identifying the cause will allow you to effectively address the underlying issue affecting your CIBIL score. 

• Review Your Credit Report for Errors

Obtain and review your credit report from CIBIL for inaccuracies, such as incorrect personal or account details. If you find any discrepancies, raise the concern with CIBIL immediately to rectify the mistakes, as these errors can negatively impact your credit score. 

• Ensure Timely Payments

Pay your existing financial obligations, such as credit card bills and loan EMIs, on or before the due date. Set up reminders or automatic payment mandates to help maintain financial discipline. Timely payments have a positive influence on your CIBIL score, as they demonstrate creditworthiness.

• Manage Credit Utilisation Ratio

Keep your credit utilisation below 30% of your total available credit limit. High credit utilisation indicates that you are overly reliant on credit, which can negatively affect your CIBIL score. Regularly monitor your spending habits and pay off outstanding balances to maintain a healthy ratio.

• Avoid Multiple Credit Applications

Avoid applying for multiple loans or credit cards in a short period, as each application results in a hard inquiry on your credit report. 

This can temporarily lower your CIBIL score. Instead, research and apply only for credit products that align with your financial needs to improve your chances of approval.

• Diversify Your Credit Mix

Having a diverse range of credit types, including both secured and unsecured loans, can improve your CIBIL score. However, it is important to ensure that you can handle the repayments comfortably before taking on additional credit.

• Maintain Older Credit Accounts

The length of your credit history contributes to your credit score. It is advisable to keep older accounts open, as this can be beneficial. Ensure these accounts remain in good standing and monitor them for any unusual activity.

By diligently following these steps, you can improve your CIBIL score and enhance your chances of loan approval. Building a strong credit profile is a gradual process that requires consistent and responsible financial behaviour.