Being denied a mortgage can be a stressful experience, especially in today’s competitive real estate market.
While it’s important to make sure your credit is ready for a mortgage before you start the process, it’s a good idea to understand the potential reasons for denial and what you can do to avoid a major setback in your home buying plans.
How often does an underwriter refuse a loan?
In 2020, 9.3% of applicants were denied a home purchase loan, according to data collected under the Home Mortgage Disclosure Act. However, some loan programs have a higher rejection rate than others. Here’s how it breaks down.
- Federal Housing Administration Loans: 14.1% refusal rate.
- Giant Loans: 11% refusal rate.
- Compliant Conventional Loans: 7.6% refusal rate.
- Refinance loans: 13.2% refusal rate.
Mortgage denials can also vary widely based on demographics. According to the data, black and Latino applicants were denied a home purchase loan at a rate of 18.1% and 12.5%, respectively, compared to 9.7% for Asian applicants and 6 .9% for white applicants.
Reasons an underwriter declined your mortgage
Why would an underwriter refuse a loan? “There can be many different reasons why a loan is not approved, ranging from not being able to show sufficient income to repay the loan, to not having an acceptable credit history or even the property that is not valued at the expected value,” said Doug Perry, strategic finance advisor at Real Estate Bees.
Knowing these potential reasons can not only help you know what to do if your application is denied, but also what to do to avoid the denial in the first place:
- Low credit score. Different loan programs have different credit score requirements. For example, a conventional loan usually requires a score of 620, but you may be able to get an FHA loan with a score of 580 or even a score of 500 if you have a high enough down payment.
- High debt to income ratio. You generally need a debt-to-income ratio of 43% or less – this means that your total debt payments, including your proposed mortgage fees, are 43% of your monthly gross income – but some loan programs may go up to 50%. “A high DTI signals to lenders that you may be in over your head and more likely to default,” says Mayer Dallal, managing director of mortgage lender MBANC.
- Low appraisal value. If the home’s appraisal returns well below the home’s sale price, the loan-to-value ratio, calculated by dividing the loan amount by the home’s value, may be too high for the lender. If the LTV exceeds 100%, the lender may not recover the value of the loan if you end up defaulting on the loan or if the value of the property decreases.
- Other issues with the property. Some loan programs have requirements that the property must meet to be eligible for financing. If the home inspection comes back with significant issues, the lender may consider the property a bad investment and decline your application.
- Not enough eligible funds for down payment or closing costs. Although you can finance most of the purchase price of the home, most loan programs require you to put money down using eligible funds – you can use your personal savings, proceeds from sale of your existing home or a gift, but you can’t use things like a personal loan or a credit card cash advance. And while you can usually build closing costs into the loan amount, that may not be possible if it pushes the LTV above an acceptable level.
- Other credit history issues. Even if your credit score meets the minimum requirements for a loan program, the lender can still deny your application if your credit history is limited. You may also be denied if you have significant negative items on your credit report, such as recent bankruptcy, foreclosure, or late mortgage payments.
- Recent evolution of employment. A mortgage is a significant financial commitment, which is why lenders prioritize financial stability. If you have recently lost your job or have moved into freelance work, this could be concerning. The same is true if you move on to a new job in a different field. However, if you have changed jobs and are still in the same industry, this should not be a problem.
What to do if your mortgage is declined
Depending on the reason for the denial, there may be one or more issues that you need to resolve. “If a borrower has been turned down, it’s important that they understand why, which the lender will document in writing,” says Perry. “That way they can explain what the problem is when looking for a new lender.”
“If a big bank turned you down for something other than bad credit,” says Dallal, “try explaining all your issues to a smaller lender, and they can often offer you service tailored to your individual needs.”
In some cases, you may be able to apply to another lender and get the results you want. Before proceeding, however, review the reason for the rejection and consider taking the time to address it anyway. Even if you may be approved by another lender, taking steps to improve your creditworthiness can help you get more favorable terms.
With this in mind, it is important to note that there is nothing to be embarrassed about if your loan is refused. Mortgage lenders are working in large numbers, and that’s not an indictment of your character. Although some issues may take longer to resolve than others, there can still be a clear path to home ownership. Here are some steps you can take to get there:
- Improve your credit score. If you were denied due to a low credit score, review the minimum credit score requirements to buy a home and take action to resolve any issues that may lower your score. You can start by getting a copy of your credit report and reviewing it for negative items. Potential steps include paying off credit card debt, repaying a loan, and disputing inaccurate information.
- Reduce your DTI. There are only two levers you can pull with DTI: debt repayment and income. Unfortunately, starting a scramble to earn more income won’t help much, as lenders typically require two years of self-employment income. However, if you can find a better paying job, it may help. Alternatively, you can look for opportunities to reduce your debt repayments by paying off smaller balances or refinancing debts with a longer repayment term. Remember that this last option may increase your total interest costs on these debts.
- Make a lower offer. If the appraised value of the home is much lower than the sale price, the seller may be forced to accept a lower offer, as other potential buyers may have just as much trouble getting approved for a loan. with a lower appraisal value.
- Make a larger down payment. If homes in your area are costing more than expected, you may not be able to settle for a lower offer. Instead, you can offer to deposit more money to lower the LTV enough to meet the lender’s standards.
- Consider another house. If you can’t make the math work with appraised value versus sale price, your DTI is too high for the amount you want to borrow, or the house doesn’t meet the requirements of your loan program, you you may have to keep shopping from home to find the one that best suits your needs.
- Save more money. If you don’t have enough cash in reserve to cover the down payment and closing costs, it may be a good idea to wait and save more money.
- Get a loan without down payment. If you are a first-time home buyer or qualify for a loan from the Department of Veterans Affairs or the United States Department of Agriculture, you may be able to get a mortgage with no down payment requirement. Remember that if the value of your home drops, you may find yourself under water on your mortgage.
- Apply for a down payment assistance program. If you are a first-time home buyer or have a low to moderate income, you may be eligible for a down payment assistance program, which can help you meet lender down payment requirements. funds and closing costs.
- Have someone co-sign. If your financial or credit situation is the problem, you may be able to get approved if someone co-signs your loan application. Just make sure this person can meet the lender’s eligibility criteria and understands the responsibilities of a co-signer.
- Be patient. If you’ve been turned down due to a job change or major negatives on your credit reports, you may just have to wait until you’re no longer a risk to potential lenders. Consult a mortgage advisor to get a better idea of how long to wait and what you can do in the meantime to prepare.
How to avoid denial in the first place
Getting a mortgage is a big decision, so it’s essential that you prepare your finances and credit report well in advance of your application. Here are some tips to help you maximize your chances of being approved:
- Review your credit score and credit reports and resolve potential issues.
- Determine your budget for a home, including the monthly payment and the total amount borrowed.
- Calculate your DTI and make adjustments if necessary. Don’t forget property taxes, home insurance and mortgage insurance in your calculations.
- Save enough to meet down payment and closing cost requirements and still have money left over for emergencies and other unforeseen expenses.
- Avoid applying for other loans or credit cards six to twelve months before your mortgage application, as well as during the mortgage process.
- Apply to several lenders to get a better idea of what you can qualify for.
- Consider working with a mortgage broker who can help you find the best lender for your needs.
While these steps don’t guarantee approval, they can help improve your chances of getting approved and earning a low interest rate.