Why Does A Mortgage Loan Get Denied?
10 Ways to Get A Mortgage Loan Approved
Every day, thousands of people face mortgage denial when they go through the mortgage lending process. While the law requires mortgage lenders to provide a free credit report & score to the borrower during the mortgage loan process. A mortgage lender also has to provide a list of the main reasons for the decision to deny the mortgage loans. Many people are still left with questions about the mortgage loan process even after receiving the decision from the mortgage lender. We’re here to help you understand some of the common reasons a mortgage loan application gets denied, and what you can do to improve your mortgage application approval rate.
Why Are Mortgage Loans Denied?
1. Credit Scores aren't high enough
One of the first things most lenders will look at is the borrower’s credit scores. We’ve written a lot about credit scores and how they work, including our free online course, Understanding your Credit Report and Scores. The length of your credit history, credit utilization, payment history, and more will affect a credit score.
What you can do:
When it comes to your credit score, fixing the underlying data is your top priority. Make sure your credit report is accurate and up-to-date. Many reports have errors that can lower your score and keep you from getting home mortgage loans. You can also pay off accounts, remove outdated debts, and bring delinquent accounts current to make sure your credit score is accurate and healthy.
2. Recent Credit History or Bankruptcy
The info on your report isn’t just turned into a score—your lenders will review the whole report and look for anything that makes you look like a risky borrower. If you have a recent bankruptcy, you recently applied for a lot of new credit, or you have some unpaid collections or legal judgments, then you can have your mortgage application denied even if your credit score is technically good enough to get loans.
What you can do:
A recent bankruptcy can derail a mortgage process, but there are mortgage lenders who will still work with you. You need to make sure your credit report is updated properly; if old debts that were discharged by the bankruptcy filing are still listed, they can be unfairly damaging your score. You can add a 100-word statement explaining the circumstances of your bankruptcy. These statements can go a long way toward helping a lender understand your situation and make the right lending decision.
3. Debt-to-income ratio is high
A major reason lenders reject borrowers is the debt-to-income ratio (DTI) of the borrowers. Simply, a debt-to-income ratio compares one’s debt obligations to his/her gross income on a monthly basis. So if you earn $5,000 per month and your debt's monthly payment is $2,000, your DTI is 40%. This is also known as your “back-end ratio” if it includes all of your debts, like your monthly mortgage payment, credit cards, auto, student loans, and more. Your “front-end ratio” only considers your mortgage's monthly payments compared to your income.
These ratios are expressed as front/back. So if your monthly gross income is $5,000, your mortgage monthly payment is $1,200, and your total debt monthly payment is $2,000, your ratio is 24/40.
Please note the mortgage's monthly payment includes both calculations. The back-end is different; it also includes other debt obligations. Things like child support and alimony are considered a kind of debt and are included in the back-end ratio.
What you can do:
Improving your debt-to-income ratios can involve paying down debt, increasing income, or doing something to adjust your monthly mortgage payment. There are a lot of strategies that you can use to improve these numbers and increase your chances of getting approved.
4. Employment History Isn’t Consistent
One factor lenders take seriously is your job security. They want to be sure you are going to be able to make your monthly mortgage payments for years to come. If you’ve recently changed jobs, or are changing jobs, this can be a red flag for a loan officer.
Even if you are changing positions for the same employer, lenders can become skittish. If your new position doesn’t seem similar enough to your previous one. You could look like a riskier proposition; if your new job doesn’t work out, you could be out of work or demoted to a position where you might not be able to afford your monthly payments for the entire term.
What you can do:
Make sure you document all your sources of income accurately and completely. Don’t let your mortgage underwriter or loan officer uncover any nasty surprises; being unable to properly document your income is a major reason for loan program denial.
5. Qualifying Income Isn’t Enough
While your credit score doesn’t factor in your income at all, lenders will look at this closely. Your employment history, which we have established, should be as stable as possible; your income should be regular and enough to let you afford your loan amount.
Not all income will count; only “qualifying income” is included when calculating your debt-to-income ratio (DTI). If you get cash income that isn’t reported, or certain bonuses and commissions, they may not help you with a loan approval. Self-employed people will have to work extra hard to get their income to count towards home loans.
Any change in income after getting pre-approved will derail eligible borrowers process. Any large, recent deposits or bank transfers will trigger questions from your underwriter. They will want to document when and where the money came from, and this will slow down the process.
Don’t make random transfers or deposits; once the loan process begins; maintain the status quo! The only deposits your lender should see are your regular, predictable paychecks (preferably being direct-deposited into your bank accounts). Unusual transactions should be avoided during this part of the borrowing process. If you can’t properly document your income, you’ll be more likely to be rejected.
What you can do:
Make sure to document all sources of income accurately and completely. Properly documenting income will allow for a smoother process for borrowers during the loan program process.
6. Debts Weren’t Disclosed
Like changing jobs or making deposits, it’s important not to take on any new debts after the loan process begins. The underwriter will go back and check your credit report prior to final approval, even if you’ve been pre-approved. Going out and getting an auto loan while you’re trying to get approved for a mortgage could definitely get your application denied.
Some private debts that aren’t in your credit history may still come up in a public records search, so make sure you disclose them early on to avoid problems later in the loan process. Things like child support might not seem like debt, but they must be included in your application, since they are financial obligations you must meet, and will be factored into your DTI.
What you can do:
Don’t leave out any of your debt obligations on your application, even debts that might not appear on your credit report. Lenders are thorough and they will find out about all of your debts—so you might as well own up to all of your obligations right up front.
7. Risk for the Lender is Too High
Secured loans need collateral to be approved. If you get a secured loan against your car's title, the lender will repossess your car if you don’t pay your monthly payment. With a home loan, the property itself can be foreclosed on if you can’t pay your monthly payment, but lenders take a risk of big losses if they have to auction off the house. If you make a large down payment and not the minimum down payment, you make it less risky for the lender since they can make their money back even if they auction your home off at below-market prices.
Lenders also want to see that you have cash reserves left after you make your down payment. Taxes, moving expenses, home repairs…these things can take a bite out of your savings, and lenders know that. They want to be sure you have enough cash on hand to get through the first few months of homeownership and aren’t going to have trouble making your monthly payments right away.
What you can do:
Save up to build the biggest down payment you can, and set aside cash reserves to make sure you can truly afford homeownership.
8. Your Application Has Errors
If your application has any mistakes or errors, the lender will see them and your loan application can be rejected on the spot. Lenders have a lot of applications to review, and one that is incomplete or riddled with errors is not going to be worth their time.
If anything is exaggerated on your application, like your income, this will create problems. You need to document every source of income you state on your application, as well as every debt obligation you have. Anything you leave out or exaggerate will come back to bite you during the underwriting process.
What you can do:
Fill out your application completely; don’t leave out any prior bankruptcies, foreclosures, or short sales. Report losses you have; lenders will check your tax returns carefully, so make sure you document what they will see on your loan application.
9. Bad Timing With Life Events
A recent bankruptcy, divorce, legal battle, or health issue can make it a bad time for you to be getting the right mortgage. Sometimes you have to wait until the circumstances are right.
With a second mortgage, lenders will have a waiting period if the home has been on the market recently. Don’t apply for a 2nd mortgage or refinance if you’ve recently listed your home for sale.
Sometimes, the loan is derailed through no fault of your own. If the seller of the property you are trying to buy can’t get a clear title, or has some problem getting mortgage insurance coverage on the property, then you can be denied even if your application is perfect.
Finally, a bad or inexperienced mortgage professional can lead to a denied loan. Whether they missed legitimate early warning signs on your application that could have been corrected, or they made rookie mistakes, you may have just caught a case of bad luck when you applied for your home loan.
What you can do:
Do some advance work to make sure your timing is right. Review your credit report early and make sure there are no surprises when you go in to apply for the loan. Gather all the documents you need ahead of time, including W2 and tax returns, pay stubs, bank statements, etc. Be ready to document all of your sources of income and all of your financial obligations.
10. Subjective Rejection From the Lender
Even after everything else is done and the application looks good, a mortgage officer can look over your application and downgrade it to a rejection based on subjective factors. If you’re self-employed, have been on the job for a short time, have a short history, or simply don’t have enough cash reserves in the bank, your underwriter can reject a loan application that was initially approved.
This is called “layered risk”. Even though the application is approved by a computer, a human can look at multiple negatives and decide it’s just too risky. Even if you have a down payment, you can get rejected if those funds were a gift, rather than money you earned. Lenders can also be uncomfortable if they see your new mortgage's estimated monthly payment is going to be dramatically higher than the rent you are used to paying.
What you can do:
Free credit and debt counseling, pre-purchase housing counseling, and other services are at your disposal. We’ve been helping the community get on the road to financial freedom for 50 years.
Whether your home mortgage application was denied, or you are just starting the process of applying for a home mortgage, call us today at 800-294-3896 for free, confidential help.
We’ll help you figure out the best plan to get qualified for the loan you need.
Strategies for Overcoming Loan Denial
Before Applying For a Loan:
- Gather all of the documents you need. Missing docs lead to rejected loans.
- Build savings to afford a down payment and build cash reserves.
- Pay down debts to improve your credit and DTI.
- Review your credit and make sure everything is accurate and up to date. Address any negative items.
- Calculate your income completely and correctly.
- Check out our “Guide to Homeownership”.
If You’ve Already Been Rejected For a Loan:
- Check your credit report. Make sure your positive history is included along with the negative. Correct any erroneous or outdated info.
- Talk to your lender; under the Equal Credit Opportunity Act, the lender must provide a written explanation for why you were turned down. Our certified housing counselor can look over the documents with you and help you understand everything it says.
- Work to remove any negative credit entries on your reports; you may be able to negotiate this removal in exchange for paying off a collection account, for example.
- Work to re-establish good credit, either by bringing delinquent accounts current or establishing new credit that you can manage successfully.
- If you were denied for not having enough resources or income, look into programs for low-to-moderate income borrowers, or loans with a lower down payment, like the Federal Housing Administration (FHA loans) or Department of Veterans Affairs' loans (for eligible veterans). Our homeowner counseling services can help you determine what loan program would be best for your situation.
- Renegotiate the loan—if the loan is too close to 100% of the property's value, you will get denied. You should strive to borrow 80% or less of the home’s value to avoid paying private mortgage insurance (PMI). If you simply must borrow more than that, keep the loan below 95% of the home’s value. Either by increasing your minimum down payment, or reducing the selling price to 95% of the value, you may be able to get another change. Consider getting a new appraisal if you think the property wasn’t valued correctly.
- Once you get counseling or assistance to correct everything that held you back the first time, apply for a new loan and present yourself in the best light possible. Do everything as if you are trying to impress someone important, like you're applying for an important job. Think of counseling as passionate people helping you put together your resume. A well-prepared application to a new lender can give you different results, especially considering you may have a new loan officer and a different appraiser. Each fresh set of eyes on your improved application can mean getting approved the second time around.
