Getting Loan Approval: Credit History vs Down Payment

When you are seeking loan approval, your credit history and down payment will both be essential. Depending on the type of loan, however, one may outweigh the other in importance. Generally speaking, down payment requirements may be lower either on a small loan or on a loan with an additional guaranty.

Credit History Is More Important on Small Loans

On a small, personal loan, a down payment may not even be required. For example, there is typically no down payment requirement on a small personal credit card or credit line. When limits are less than $10,000, even a 10 percent down payment may not amount to more than a few hundred dollars, and this gives the lender very little security against default. Therefore, a lender will be more concerned with the borrower's credit history. This is a better indicator of any possibility of default than a nominal down payment a borrower would likely simply sacrifice if default did occur.

Credit History Is More Important on Federally Insured Loans

A federally insured loan has a guaranty from the most reliable possible source. For example, an FHA loan is insured by the U.S. Department of Housing and Urban Development. The chance for default is negated on the loan, and the lender will generally accept any loan that has this guaranty. The FHA, however, will not accept just any borrower for this guaranty. The borrower must have excellent credit so the government has reason to believe they will not have to exercise their obligation to purchase the loan in the case of default. Since the goal of the FHA is to expand home ownership, the FHA may compromise on down payment requirements as long as a borrower's credit is strong. For example, the FHA has a low down payment option of 3.5 percent for qualified borrowers.

Down Payment Is More Important on Secured Loans

For a secured loan, the lender has a good reason to believe the borrower will not default. If the borrower does default, the collateral will be sacrificed. This collateral and any down payment are the most important factors in improving the loan. In this case, the credit score of the borrower is more likely to affect loan terms than to result in disqualification for the loan itself. For example, car lenders often lend money to less qualified borrowers who have a large down payment. They can repossess the automobile and keep the down payment in the case of default, so there is little risk.

Exceptions

Mortgages are exceptions to these guidelines for the most part. Aside from federally insured mortgages, these loans require both a large down payment and an excellent credit score. Mortgages are an exception because of their size; other large loans may also be exceptions to these general guidelines. Large home construction loans are unique, and they will require both good credit and a large down payment. Home equity loans and small business loans will also likely require both aspects for a lender to qualify.

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