Why Debt Consolidation Loans Get Denied

You did all the work to find the lender you want and loan terms you need—just to get that dreaded "denied." You're left staring at the screen in frustration, wondering what you could've done differently.

Debt consolidation loans are denied for all kinds of reasons, some of them outside your control, but you're not powerless. There are ways to make yourself a more-appealing borrower. You may also have options that don't involve a consolidation loan.

Lenders have to tell you why you were denied—you usually get a letter in the mail—so you know what to improve. Let’s look at some common reasons your loan can be denied and what your options may be afterward.

Common Reasons for Debt Consolidation Loan Denial

Every lender has its own requirements for lending. If you're denied, it's often because your qualifications didn't line up with the lender's requirements—usually a matter of existing debt, income, or credit.

Your debt-to-income (DTI) ratio is too high

One way lenders determine if you can afford a new loan is to look at your debt-to-income (DTI) ratio. This is found by dividing your total monthly debt and housing payments by your pre-tax monthly income.

Lenders aren't just crunching the numbers for your current debts. They also add in your future loan payment to make sure it doesn't push your DTI over the limit.

What that exact limit is varies by lender. A DTI below 36% is considered ideal, but 43% is a common cutoff. Anything over 50% is likely to make it harder to win approval. 

You might have a little wiggle room if you're specifically getting a loan for debt consolidation, because some lenders don't count the debt you're consolidating in your DTI. You may need to agree to let the lender pay your creditors directly for this to work.

Your credit score or credit history needs work

Lenders like to know you'll pay back what you borrow. They get an idea of how you've handled debt in the past via your credit report, a snapshot of your credit history that gives lenders a quick way to evaluate your credit standing.

Most lenders have minimum credit score requirements. A low credit score means you don't have much credit history, or that your history includes negative items like late payments, delinquent accounts, or high debt levels. In either case, lenders might feel that lending to you is too risky, and deny your loan application.

The good news is that your credit isn't set in stone. You could build up your credit over time with smart moves like on-time debt payments and keeping your credit card balances low.

Your income is inconsistent or insufficient

Your income factors into your debt-to-income ratio, but that's not the only reason lenders consider it. They also want to see the source of that income, and they want to know it’s  consistent and reliable.

If your income is inconsistent, lenders may wonder if you'll have trouble making loan payments every month. Similarly, if you have an unstable work history, a lender may be concerned about your ability to pay back a loan.

You don't have enough collateral or equity

Personal loans are typically unsecured, meaning you don't need collateral (something of value) to back up the loan. But that's not the only kind of loan used for consolidating debt. Some folks use a secured home equity loan or home equity line of credit (HELOC).

Home equity loans use your home's equity—the current market value minus the amount you still owe on your mortgage—as collateral. How much you can borrow using that equity depends on your combined loan-to-value (CLTV) ratio. This is calculated by adding up all the loans on your home, then dividing that number by the market value.

Many lenders allow a maximum CLTV around 85%— including the home equity loan or HELOC you want to take out. So if you only have 15% equity in your home (or less), your application for a consolidation loan could be denied.

Example: Your home’s value is $400,000 and you still owe $300,000 on the mortgage. The lender’s CLTV limit is 85%. You could apply to borrow $40,000. 

What to Do After a Debt Consolidation Loan Denial

Being denied a consolidation loan doesn't have to be the end. There are still things you can do, even if your application has been denied.

First, find out what happened. Lenders are required to send an “adverse action” notice that explains why your application was denied and says which credit bureau they used. Read this letter carefully. Also, get copies of your credit reports—you can do this for free at AnnualCreditReport.com—so you can see the same data the lenders did.

If your credit reports contain errors, you can dispute them with the credit bureaus. If you get the issue fixed, consider requesting reconsideration from the lender.

Even if an error wasn't the problem, knowing why you were denied could help you come up with a game plan. That might be addressing your DTI or credit score before applying again—or it could be looking for an alternative to consolidation.

Debt Relief Options When a Loan Isn't Right for You

Just because you were denied a consolidation loan doesn't mean you're out of options. You could try another lender, or you could work to improve your qualifications. That said, sometimes consolidation just isn't the right move. Consider this a chance to explore other options to find something that better fits your situation. Here are some other options you might find useful.

DIY debt payoff

Even if the consolidation loan didn't work out, you could pay off your debts yourself with a DIY debt payoff strategy. The debt avalanche method prioritizes paying off your highest-interest debt first, which could reduce how much interest you pay overall. If you need a little extra motivation to keep going, the debt snowball method prioritizes paying off your smallest debt first, giving you a quick win.

Professional debt relief

When financial hardship gets in the way of paying your debts, debt relief through debt settlement could be an option. This involves negotiating with your creditors, asking them to accept less than you owe and forgive the rest of your debt. 

You can negotiate on your own, or you could hire a professional debt relief company to do so on your behalf. Debt relief doesn't require taking on a new loan, and your credit score doesn't impact whether you qualify. For professional debt relief, you do need some form of income so you can make monthly payments into a debt settlement account you own and control.

Debt management plan

If you can afford your debts but need some guidance, a debt management plan (DMP) from a credit counseling agency could be the right move. A credit counselor can help you come up with a repayment plan, and may negotiate with creditors to ask that they lower your interest rate or get rid of certain fees. 

You don't need good credit to be eligible, and you don't take out a new loan. You pay the credit counseling agency a single monthly payment, then the agency pays your creditors. You typically repay your enrolled debts within three to five years.

Bankruptcy

If your debt is overwhelming and you have no hope of paying it back, it could be worth considering bankruptcy. Chapter 7 bankruptcy could allow you to get rid of your unsecured debt for good. It could involve the court selling some of your assets and using the money to repay your creditors. You may not qualify for Chapter 7 if you make too much money.

If you don't qualify for Chapter 7 or have assets you wish to save, Chapter 13 bankruptcy could be an option. This requires restructuring your debts through a repayment plan that usually takes five years.

How to Move Forward After Loan Denial

As frustrating as being denied a loan can be, it's not the end of your financial journey. You still have options, from building up your credit to trying various forms of debt relief. Start by figuring out why you were denied, then work from there. 

The power to change your future is still in your hands; a loan denial doesn't take that away from you. If you're not sure about your next move, consider contacting a debt professional for a free consultation. They can help you decide if debt settlement is the right way forward.