Getting approved for a mortgage isn’t easy. However, you can reduce the odds of having your mortgage application denied. Knowing the common reasons for mortgage application denials can help you to take action in advance to ensure your mortgage application meets your lender’s criteria.
In 2019, about 8% of all U.S. homebuyers had their mortgage loan application to purchase a single-family home denied, according to data that mortgage lenders submitted to the federal government under the Home Mortgage Disclosure Act. If your mortgage application has been denied, it doesn’t mean you can never be a homeowner.
There are many reasons why a mortgage lender does not approve a mortgage application. Fortunately, the reason(s) for denial can often be overcome. The key to success is understanding the reason(s) and what you can do to correct the problem(s).
5 Common Reasons Mortgage Loans Are Denied
Understanding the top reasons why mortgage applications get rejected can help you avoid receiving a denial.
1 – High Debt-to-Income
Debt-to-income ratio represents the percentage of your income that goes towards paying your monthly debts, and helps a lender determine how much they will lend based on your ability to repay the money you have applied to borrow.
FinLocker recommends that borrowers achieve a debt-to-income (DTI) ratio below 45%, but a lower ratio is better. Debt-to-income can be calculated by adding up all of your monthly debt payments, such as rent, car payments, student loan payments, credit card payments, and weighing them against your gross income. FinLocker users can connect their bank and credit card accounts, loans and other debts, then use the readiness assessment to monitor their progress towards a lower DTI.
Tips to reduce your DTI: Pay down debt (credit card balances, student loan, auto loan, personal loan) or increase your income.
2 – Low Credit Score
The higher your credit score, the more likely your mortgage application will be approved, and the lower the interest rate you will be offered.
Most mortgage lenders recommend having a minimum 620 credit score to apply for a conventional or FHA home loan. While some mortgage programs will accept a lower credit score, they will charge a higher interest rate because a lower credit score indicates that the applicant has a higher risk of default.
Tips to build your credit score:
- Pay your bills on time each month.
- Pay down your credit cards.
- Don’t open new credit card accounts.
- Limit spending on credit cards to what you can pay off each month.
- Review your credit reports for errors.
3 – Credit History
Past delinquencies, bankruptcy, a previously owned home lost due to foreclosure, or a short sale, can all come back to haunt mortgage loan applicants, even if those accounts have been settled. When lenders tighten their mortgage lending rules, which happened in 2020 due to the economic uncertainty resulting from the coronavirus pandemic, homebuyers can face additional hurdles to qualify for a home loan. For example, a borrower who has reestablished good credit can apply for an FHA home loan two years after a Chapter 7 bankruptcy. However, in times of economic uncertainty, a lender might require a longer waiting period.
Tips to repair credit history: Before applying for a mortgage, you should review your credit reports from each credit reporting agency. You have the right to obtain free credit reports from annualcreditreport.com or 877-322-8228, the only authorized source under federal law. Check that any previously delinquent accounts have been updated to reflect their current status, for example, paid in full. The website has advice on how to file a dispute if you see any errors.
To improve your credit history:
- Start by paying your bills on time each month.
- Don’t close unused credit card accounts when they’re paid off.
- Cut up the card if the temptation is too great to use them.
4 – Low Down Payment
Lenders look carefully at the loan-to-value (LTV) ratio on your mortgage application to compare how much you’re asking to borrow versus the value of the home you want to purchase. While you can apply for a home loan with a 3% down payment, and VA and USDA home loans will accept zero down payment from qualified applicants, a higher down payment will lower your LTV.
Lenders like to see low LTV ratios as it helps protect their investment if you’re unable to make your mortgage payments at a future date. That’s why most mortgage programs with an LTV above 80% require private mortgage insurance, which is paid with your monthly mortgage payment.
Tips to save a higher down payment: While it’s important to pay down your debts to lower your DTI, it’s just as important to save money to increase your down payment. Once you’ve got your DTI paid down to below 45%, start saving most of the cash flow you had been using to pay down your debts.
5 – Low Appraisal
Home prices incrementally soar in a hot housing market, so the appraiser might find it difficult to find recently sold homes in that neighborhood to use for the appraisal comparison. If the appraisal for the property you want to purchase is significantly lower than the purchase price, the loan-to-value (LTV) may be higher than the lender can legally approve.
Tips to resolving a low appraisal: Fortunately, property valuation issues can often be resolved. This is when it’s good to be working with an experienced real estate agent because they can renegotiate the property’s purchase price. If the seller won’t budge on the sales price, another option is to make a larger down payment to make up the difference between the lender’s loan amount and the sales price. Alternatively, find another home within your budget that will appraise for the market price.
No one wants their mortgage loan denied, especially if they were pre-qualified or pre-approved. Fortunately, most of the reasons mortgage applications are denied can be prevented. If your financial circumstances have changed since you got pre-qualified, pre-approved, or denied, it’s important to talk to your lender before submitting a mortgage application. They can advise you if your current circumstances will affect the likelihood of your mortgage being approved or denied, and advise you how to improve your odds for approval.