Loan Demand Dips As Consumer Budgets Are Squeezed And Lending Standards Peak

Driven by eye-watering interest rates and turbulent economic conditions, U.S. banks and private lenders are slamming on the brakes and back-peddling on new loan and credit card applications, deliberately tightening standards and making it harder for borrowers to get approval.

In an October 2023 survey conducted by the Federal Reserve, the Board of Governors observed that big-time lenders and other major U.S. banks are less likely to approve new applications given the current economic climate and the fall of several regional banks, including Silicon Valley Bank, First Republic, and Signature Bank last year.

Most banks are tightening application requirements for nearly every borrower, including businesses. The Feds survey found that banks and lenders are less likely to approve a new auto loan or credit card applications for borrowers with a FICO score or equivalent of 620 to 680.

Borrowers will need to bulk up on their credit scores this year, as the Fed’s survey suggests that banks and lenders are more likely to approve auto loan and credit card applications for borrowers with a FICO score or equivalent of 720 or higher.

In fact, some industry data provided by Chicago-based online credit lender CreditNinja revealed that more than 53 percent of Americans that have applied for a credit card, loan or auto vehicle have been rejected due to a poor credit score. More surprisingly, Americans aren’t estranged from debt, with roughly 80 percent of American adults owning some sort of credit lender, paying up billions in loan fees each year.

Consequently, demand for loans has plummeted sharply throughout much of last year. Roughly 60% of banks cited a weaker demand for home mortgages during the third quarter of last year. This was a not-so-surprising jump, considering around 43% of banks cited dwindling demand in the second quarter.

Mortgages are among the biggest loans consumers will typically take out in their lifetime. Although mortgages and other big-ticket purchases, including business, auto, and personal loans are some of the loftier debt consumers tend to take on, interest rates are squeezing their already tight budgets.

This shouldn’t come as a surprise. The national average for a fixed 30-year mortgage was standing around 7.03% during the first three weeks of January 2024, according to data by Bankrate.

Lenders have become more hawkish in recent months over current economic circumstances and the possibility of a recession. While the U.S. narrowly scattered past a recession - depending on whom you ask - the Fed’s aggressive monetary tightening has caused a domino effect throughout the economy, leaving consumers and businesses in a tough position.

Tough Standards and Sticky Results

Banks and lenders are toughening up their standards, deliberately being more choosy over new credit and loan applications. Even those individuals and businesses that are comfortable with affording new lines of credit will find it more challenging in the coming months to be approved, as lenders continue to limit their credit amid economic headwinds.

Loan standards across the board have become more demanding. Most types of loans, including business, mortgage, credit card, and automotive loans are seeing continuous versions of application standards due to economic headwinds.

By the numbers, the Feds survey revealed that banks and lenders are introducing a flurry of new standards in an attempt to curb demand and keep borrowers at bay, for now at least until conditions have improved.

On average, 50% of banks have cited that standards for loans to small firms have become more lengthy, and seemingly arduous. This represented a 2.5% percentage point increase between the second and third quarters of last year.

Elsewhere, consumers might find themselves having to jump from lender to lender in the hopes of securing new loans. Roughly 36% of banks have already increased the standards for new credit card loans, and fewer banks are now approving auto loans.

Whether borrowers are looking to take out a new mortgage, or credit card - tighter standards and new policy changes would see them having to endure an arduous application process and submit stacks of financial information before they are likely to be approved.

While being approved for a loan or credit has generally been a lengthy process, new requirements could make the weighting process even longer, and exclude more people from applying in the first place.

Aside from the routine documentation and requirements that banks will be looking at, such as having a positive bank balance, debt-to-income (DTI) ratio, a steady stream of income, and a good credit score, lenders have extended their demands even further.

This would mean that some Americans might find themselves having to submit countless documentation, from the last several years of tax returns, income, and employment history, to proof of employment and residence. Not only this, but some lenders tend to favor borrowers that already have an existing relationship with either the lender themselves or the bank.

For first-time buyers, the process of being approved just became a lot more tedious, and a lot more difficult. Securing new loans is not only becoming harder for borrowers, but some experts suggest that small firms and businesses will find themselves having to navigate similar obstacles when applying for a line of credit.

The hero in disguise

Perhaps tougher lending practices and standards are the wake-up call American consumers need following the recent months of economic headwinds.

Consumers are stepping into the new year with a tremendous amount of debt. The collective U.S. household debt hit a record of $1.73 trillion, according to data by the Federal Reserve Bank of New York.

This comes after Americans’ collective credit card debt soared above $1 trillion during the second quarter of last year, with total credit card balance rising more than $45 billion between the first and second quarters of last year.

November 2023 witnessed another spike of more than $23.75 billion, far surpassing economist's expectations of a $9 billion increase.

Despite headline inflation trending downwards in recent months, the same data provided by the Federal Reserve Bank of New York showed that around a quarter of American consumers were still holding onto 2022 holiday shipping debt ahead of December last year.

The total U.S. household debt has steadily been increasing over recent years, rising 4.8% between November 2022 to November 2023, with credit card debt seeing the biggest jump of more than 16.6%.

While more Americans may be using their credit cards to cover expenses and higher costs, perhaps the stronger loan standards could potentially act as a wake-up call to American consumers who’ve been running up their debt in recent years.

Yet, this could come at a time when the Federal Reserve could initiate a trio of interest rate cuts this year, making big-ticket purchases easier for consumers, including taking on larger amounts of debt, such as mortgages, auto, and personal loans.

Although it’s not yet certain when the Feds could be looking to begin loosening interest rates this year, Americans will need to hold on a bit longer if they’re hoping to be approved for a big loan this year.

Whether that could send banks and lenders back into overdrive is yet unclear, Americans could perhaps come to terms with even tougher loan standards as banks hold steady on their outlook towards the year and uncertain economic conditions.