Buying a home can be one of the most important milestones in your life. Yet the process of getting approved for a mortgage can be complicated and time-consuming, with no guarantee of success.
Mortgage approvals have dozens of requirements and seemingly endless hurdles you have to jump over. After the heaps of paperwork you’ll need to fill out, the potential lender will have to verify your financial information and history by looking at your income, debts, credit history, tax returns, and other documents. They will also perform an appraisal of the property as well as a title search.
Sadly, despite all that work and effort, you might still have your mortgage application denied. Even after gathering the appropriate documentation, going back and forth with the lender, waiting for an appraisal to be completed, and then finally, waiting to see whether you’ll finally get the house of your dream, you might still find your application has fallen short. That's okay! It can happen to anyone.
The good news is that mortgage denial can be avoided—and even if it’s already happened, there are still steps you can take to give you a better chance of approval when you start the process over. So what’s going on? Why was your mortgage application denied in the first place?
Why Was My Mortgage Denied?
Unfortunately, there are many possible reasons why your mortgage application got denied. Some of the most common ones include: having a high debt-to-income ratio (DTI), excessive debt, and poor credit history. The debt-to-income ratio is a measurement of how much money you make (monthly income) vs. how much debt you owe. This is very important because a high DTI can alert potential lenders to the fact that you might not be able to make monthly mortgage payments consistently because most of your income is being depleted by your existing monthly debt payments.
Most lenders are looking for a DTI ratio lower than 40%. High debt-to-income ratios constitute about 26% of mortgage application rejections. In order to figure out your DTI ratio, divide your monthly debts by your monthly gross income. Excessive debt not only contributes to a high DTI ratio, but it also gives lenders the impression that you won’t be debt-free any time soon.
Another common and very important factor when it comes to mortgage denial is having a poor credit history, which constitutes another 26% of application rejections. A poor credit history or score is a huge red flag for lenders. It shows them that you have not been consistently paying your debts and makes you seem like a financial risk. Credit reports go back 7 years, but most lenders will focus on the last 2 years of activity, so make sure to look through your credit report and check if there are any mistakes in the last 2 years that you can get taken off your report. Some lenders also require a certain number of open credit lines that have been active for a minimum number of years.
Other factors that can contribute to a mortgage application denial include:
- Insufficient collateral (constitutes 17% of rejections)- Lenders hire an appraiser to inspect the property and make sure that the property is worth the mortgage. This is how the lender makes sure that neither of you is paying more than what the property is worth.
- Undocumented income- You need to prove to your lender that you can pay your monthly bills and a mortgage. In order to establish this, you need to provide proper documentation (tax returns and records of assets and finances).
- Self-employed for under 2 years, or too many company write-offs as a self-employed borrower
- Recent purchase or lease of a new car
- Business debt
- Early Retirement
- Too many changes in employment history
- Recently opening or closing a credit card
- Owing child support or alimony
- Over-drafted checking account
- Suspicious money movements in your account
In any case, the loan officer in charge of your mortgage application should provide you with detailed information as to why your application was denied. Make sure to try and acquire as much information from your loan officer as possible, taking the extra step to ask what advice they might have regarding future mortgage applications.
Steps for Next Time
Now that you have a better idea of why your mortgage application was denied, let’s plan out your next steps.
First, consider the three main reasons most people have their mortgage application denied: a high debt-to-income ratio, poor credit history, and insufficient collateral. If your mortgage application was denied because of your DTI ratio or poor credit history/score, there are several steps you can take to make improvements on both of these.
Step 1: Debt-to-Income Ratio & Credit
Start off by examining your credit report closely, looking for any errors that could be affecting your rating, and which you could try to get taken off your report. Check here for the best credit reporting. Disputing errors can be done in a number of different ways: by submitting a dispute to the credit bureau, filing a dispute with the business itself, making a goodwill request for the deletion, or simply waiting out the credit reporting time limit. Be very careful of "pay for delete" services, which can often be a scam.
Follow this up by paying off as much of your debt as you can, starting with credit card debt. The reason for this is twofold. Even if the balance is lower than on other debt such as student loans, credit card debt is among the most expensive due to its high interest rates. Additionally, student loan debt is considered an investment in your future and therefore looked at more favorably, even in the case of very high balances.
In any case, the general idea is to lower your monthly debt as much as possible, so that your DTI ratio goes down. If you are burdened with monumental student debt, consider switching to an income-based repayment plan to see if you can bring your monthly payments down, which in turn will help with your DTI. If paying off your debts is not an option, other ways to improve your DTI include refinancing high interest debts (student loans, personal loans, and car loans, for example), acquiring lower rates on your credit cards, and switching to a credit card with 0% interest (keeping in mind that this is usually only an introductory offer, and the outstanding balance must be paid within a specified timeframe). Also, keep in mind that the larger the down payment on your mortgage, the lower your DTI.
Step 2: Work on Your Credit Score
In terms of improving your credit score, once you’ve paid off as much of your debt as possible—and found and removed any errors in your credit report—there are still a couple of things you can do, like becoming an authorized user on the credit card account of a trusted friend or family member. The person’s account needs to be in good standing, it can’t have late payments, and it must have been opened years ago, so it has an established history of responsible financial practices. This method can raise your score by up to 30 points!
For more information regarding how credit scores work, click here.
Step 3: Work with Collateral
If your mortgage application was denied because of insufficient collateral, you have two options. First, you can request another appraisal if you believe the appraiser missed some important points or got measurements wrong, for example. If the lender redoes your appraisal, but it still doesn’t work out, you can always go to another lender who will then send out another appraiser. If none of this works, the other option is looking for a smaller home that requires a smaller mortgage. This is especially recommended if your debt-to-income ratio is too high, as a smaller mortgage will result in a lower DTI.
Step 4: Consider Other Alternatives
If the first lender denied your mortgage application, don’t despair. Different lenders have different requirements and can also offer various types of loans, including those specifically meant for people with bad credit (with higher interest rates and an adjustable-rate, rather than a fixed-rate). There are also Federal Housing Administration (FHA) loans, which is meant for first-time home buyers with credit scores over 500. This mortgage lets the buyers make low down payments (between 3.5% and 10%) depending on their credit score. For a 3.5% down payment, the buyer needs to have a credit score of 580 or more. Remember, just because you weren’t the right fit for a particular lender, that doesn’t mean that you’re out of options. Shop around and see what other lenders in your area have to offer.
Step 5: Reapply
Now that you’ve figured out exactly what it was that got your mortgage application denied, and have a plan for moving forward, it’s time to reapply. Just remember to work on your credit, document all of your income thoroughly, and keep a record of your financial documents.