How to Get a Loan During a Recession

Does a Recession Affect Your Ability to Get a Loan?

During a recession, lenders may decide to tighten up their lending. During the 2008 financial crisis, for example, banks suffered losses in part due to "subprime" lending to borrowers who were unqualified and ultimately defaulted on loans. Regulators responded by requiring banks to be more stringent with their loan qualifications—and to lend out a smaller proportion of their assets to keep them from over-leveraging. Between 2007 and 2008, mortgage loan originations dropped 31%, from $1.6 trillion to $1.1 trillion.

Learn more: What Does Subprime Mean?

But that's only half the story. Job losses (or the threat of them), declining home values and general anxiety about finances may make individual consumers less inclined to seek out a mortgage, auto loan or personal loan. Missed payments and bankruptcies can damage credit scores, making it more difficult to obtain a loan. If lenders require more documentation, proving self-employment income on a loan application could also become more complicated.

What Do Lenders Look for on a Loan Application?

Lenders are likely to take a harder look at your credit scores and reports when the economy is tight, but that's only one of many factors lenders consider. Be prepared for lenders to check out the following information:

• Income: The more regular your income is, the better. If you've recently lost your job or been furloughed, the disruption to your income may be a red flag.
• Credit score and report: Your credit history shows lenders how you manage credit and debt. It also provides a snapshot of how much you currently owe, which can help lenders determine how much additional debt you can shoulder.
• Debt-to-income ratio: Lenders consider how likely you might be to repay a loan by looking at how much of your income you use to make your monthly debt payments, measured by your debt-to-income ratio (DTI). For instance, if your current mortgage payment accounts for 50% of your income, refinancing to a larger loan via a cash-out refinance might be impossible.
• Assets: In a financial emergency, would you have the funds to continue making loan payments? Lenders like to see six months' worth of expenses in savings as a backup.
• Down payment: "No money down" home and auto loans might be harder to come by—or harder to qualify for—in a recession. On the other hand, if you can put a larger down payment on a new loan, you decrease your loan amount and may increase your chances of approval.

How to Improve Your Chances of Qualifying for a Loan During a Recession

Getting a loan during a recession may mean setting the bar a little higher for yourself on the loan criteria listed above. For example, lenders may require a lower debt-to-income ratio when setting a loan amount, or a higher FICO^® Score^Θ for you to qualify for the best rates.

Here are a few steps that can help you put your best foot forward:

• Document your income. Make sure you have tax returns, pay stubs or bank statements ready so you can document all of your income on your application.
• Prove your assets. Assemble bank and brokerage statements; lenders will want proof that you have assets.
• Check your credit. Check your credit score and download your credit reports from all three credit bureaus (Experian, Transunion and Equifax) at AnnualCreditReport.com. You can also check your credit report with Experian anytime. Different lenders may set different criteria for the best rates and approval.
• Get prequalified or preapproved. Sometimes the best way to find out whether you can get a loan is to apply for prequalification or preapproval. Even if your initial request is declined, you may learn where to make adjustments to improve your chances of getting a loan.
• Consider a cosigner or co-borrower. A cosigner with a high (or steady) income, substantial assets and/or a good credit score can help you qualify if you're having trouble qualifying for a loan. However, be aware that cosigning (or co-borrowing) is a risk for your friend or family member. Make sure you'll be able to pay back the loan without defaulting or damaging their credit.

Learn more: How to Protect Your Credit During a Recession

Factors to Consider When Comparing Loans

Lenders weigh their risks carefully during a recession. Borrowers should do the same. To help manage your risks when taking out a new loan during shaky financial times, don't overlook these factors:

• Calculate costs in detail. Use a simple loan calculator to figure out precisely how much a loan will cost you. Estimate your monthly payments, monthly interest, total interest and payoff date so you can compare loans side by side—and decide whether a loan is affordable for you.
• Know your upfront expenses. Add up your upfront expenses in total: down payment, origination fees, discount points, appraisal fees and so on. Some of these can be rolled into a mortgage or auto loan, but some (like your down payment) are paid out of pocket.
• Pay attention to interest rates. Interest rates usually drop during a recession, as the Federal Reserve takes steps to keep interest rates low to stimulate the economy. When the economy improves, interest rates may rise. Think about where interest rates are (and may be headed) when you apply for a loan. If rates are low, consider a fixed-rate loan, since payments on an adjustable-rate mortgage may increase with rising interest rates. In any rate environment, be sure to compare rates from several lenders.

Loan Alternatives When You Need Money in a Recession

When you need money in a recession and a conventional loan is not in the cards, consider alternative loan sources—but be cautious. Some lenders that cater to borrowers with poor credit or limited income—such as payday lenders and auto title lenders—charge high interest rates that make it difficult to pay off your loan.

Instead, here are three alternatives that might work when a traditional installment loan does not:

• Consider peer-to-peer (P2P) lending. P2P lenders and lending circles use non-traditional lending criteria and approval methods, which could help you secure a loan in a challenging lending environment. You may also build your credit in the process.
• Check out a home equity sharing agreement. If you have equity in your home but don't have the credit score or income to qualify for a traditional loan, a home equity sharing agreement can get you a lump sum of cash in exchange for a share in your home's future value. A home equity sharing agreement may ultimately cost you more than a regular home equity loan, but it doesn't require monthly payments and could be a welcome option if traditional loans aren't available to you.
• Borrow from friends or family. Asking for money or a loan from friends or family should never be done lightly. If you have friends or family with ready resources and you're confident that you can repay them, take the time to iron out an interest rate and repayment terms (and put them on paper) in advance to avoid any conflict or misunderstanding.

Learn more: Financial Do's and Don'ts to Follow During a Recession

Should You Borrow Money During a Recession?

Deciding whether to borrow during a recession might depend on factors like your job security, income and debts and need for the money. The decision is highly individual and all yours, but here are a few things to think about, from both perspectives.

When Borrowing Money Makes Sense

The following scenarios could be signs that a loan might work for you, despite recessionary times.

• You're prequalified or preapproved for a loan. Tightening loan qualifications are an obstacle in recessionary times. If you're prequalified or preapproved, you know that getting a loan is possible.
• You're confident you'll be able to repay it. Though no one can predict the future with 100% accuracy, you probably have a sense of whether your job is secure and if your backup assets are sufficient to ride out a few economic bumps.
• You want to consolidate or refinance high-interest debt. While taking on new debt can be risky in a recession, consolidating high-interest credit card debt into a lower-interest personal loan, or refinancing a mortgage or car loan to a lower rate, could save you money, as long as you qualify.
• You're in a good position now. If you've been saving up to buy a home for years and finally have a down payment, steady income, stellar credit and a low interest rate, this could be your time—recession or not.

When Waiting Might Be Better

Some signs might point in the opposite direction. If any of the following describe your situation, you may want to think about postponing your loan.

• You've recently been denied a loan. Being denied for a loan is a sign that you may need to regroup. Try to find out what went wrong and how you can fix it, even if fixing it will take a little time.
• You're worried about job loss or financial problems. If you feel like your job may be shaky, or your emergency fund is slimmer than you'd like, think twice about adding to your debts.
• Your position might improve. In six months or a year, you might be able to raise your credit score, have a bankruptcy drop off your credit report, get a raise (and qualify for a bigger loan), pay off debt, or save more for your down payment. Waiting might pay dividends.

Tip: If buying a home or a new car can wait, or you can postpone making a big purchase, you may want to hit pause. Recession equals risk. If you can wait until sunnier economic times, you might feel more comfortable about taking on the responsibility of new debt.

The Bottom Line

Getting a loan during a recession isn't so different from getting a loan at any other time, but the requirements—and the stakes—may be a little more intense. Your credit history, income and assets may be subject to more scrutiny. And, when economic times are tough, it may be a bit more difficult to meet tighter lender requirements.

Nevertheless, it's possible to get a loan during a recession. If you're planning to apply for a home, auto or personal loan soon, you may want to sign up for free credit monitoring with Experian. You'll get access to your FICO^® Score and Experian credit report free at any time and receive notifications whenever there's a change to your credit file. Preparation is half the battle.