You finally found it — the home of your dreams. But now it’s slipping away because your mortgage loan application was denied. Amidst all of the emotions you’re feeling, it can start to feel like there’s no next step.
Buying a home is an emotional process when everything goes perfectly; any missteps amplify all of those emotions, and a loan denial can feel devastating. Since the 2008 housing crash, lenders have become more cautious, lending standards are more stringent, and now even those with a high credit score are not guaranteed approval.
Why would a home loan be denied?
You can’t fix what you don’t know, so first find out why your application wasn’t approved. Lenders are required to provide a rejection letter explaining the reason behind their decision, and you can always ask the loan officer for more information. Here are a few common reasons loans are denied, and what you can do next in each situation.
Debt-to-Income Ratio (DTI) too High
Lenders are looking for financially sound investments, and having a high debt-to-income ratio increases risk. If your monthly debt payments take up a large percentage of your income, this indicates to lenders that adding another debt payment such as a mortgage is likely to make you more financially unstable.
There are a few ways to work with a denial due to DTI. First, think about the last time you opened a new line of credit. Did you recently take out a personal loan, or apply for a new credit card? That means your DTI just jumped; it’s often recommended that you not open new lines of credit during the six to 12 months prior to applying for a mortgage.
If this isn’t the case, spend some time focusing on paying off debts before reapplying for a mortgage. Consider asking for a raise or acquiring a second job, as this increase in income will lower your overall DTI. If possible, refinance and consolidate payments to lower monthly debts.
We all know your credit score is important when it comes to applying for a mortgage, and that having a low score can hinder a lot of options. While there are several steps to take to improve your score, the important one is to first evaluate why your score is what it is.
Are there marks against your score, for late or missed payments? If any of these are incorrect accusations, dispute the marks to have them removed. On the other hand, if you have a tendency to forget when monthly payments are due, set up recurring auto payments so you don’t have to sweat it.
If you haven’t established credit prior to applying for a mortgage, lenders won’t be inclined to approve you. Opt to grow your credit in other ways, such as credit cards or personal loans. Because these are in smaller amounts, you’re more likely to get approved even if you don’t have credit history.
Low Down Payment
The down payment on a home typically ranges from 5 percent to 20 percent, and works as a good faith payment to the lender that you’re serious about your investment and intend to payback any borrowed money. If you’re denied a home loan based on not offering enough of a down payment, the lender is worried you might default down the line.
Reassess your finances and ensure you’re offering the strongest down payment you can while staying within your financial means. If you know you cannot offer any more, research different kinds of home loans that require a lower amount than the mortgage you applied for; if it’s within the 5 to 20 percent range, you’ll find a lender.
Remember that low-risk factor we were talking about that lenders are looking for? They like to see it in your employment history, too. Consistent employment at one location indicates to lenders that you’re responsible enough to hold down a job.
If employment is the reason you’ve been denied, work on establishing your job consistency while at the same time improving other factors. Taking a few years to achieve stable employment means you also have time to save up for a larger down payment to improve your DTI and credit score.
Unexplained Income or Expenses
The loan officer is going to go through everything within your finances to determine if your approval or denial. One thing that might sway them negatively? Significant income or regular expenses that aren’t documented.
This includes everything from suspicious wire transfers to a huge monetary gift from your great aunt. If there are drastic transactions in your bank account and no logical explanations, a lender might feel you’re too risky of an investment.
When reapplying, be sure to include every income-related document you have in order to answer these questions before they’re asked. If a family or friend will be paying the down payment as a gift, get a written letter from them ahead of time outlining the amount they’ll pay and making it clear that the money is a gift and is not going to be paid back.
Whether intentional or not, any pertinent information omitted from a mortgage application that is later discovered by the lender is likely to get your loan denied. Go over each section carefully when applying to ensure you’ve entered information correctly.
Additionally, be upfront with your lender about any debts or financial challenges you’re facing. If they know ahead of time, they can work with you to find a way around the problem.
Risky Moves After Pre-Approval
If you’ve taken the steps to get pre-approved for a mortgage, don’t sabotage yourself by damaging your credit after the fact. Pre-approval is contingent upon your financial situation at the time of evaluation; if you are pre-approved, open up seven lines of credit, and then apply for the loan you’ve been pre-approved for, you’ll likely be denied.
If this is the case, wait out the time frame and focus on getting the rest of your finances in order before reapplying for any mortgage loans.
Low Home Appraisal
Sometimes the denial has nothing to do with you. If the home you’re looking to purchase comes back with an appraisal that is significantly lower than the loan you’re applying for, a lender will deny you because, you guessed it, it’s too high a risk.
If this is the case, you’ll need to negotiate a lower sales price from the seller or opt to pay the difference between the appraisal and the loan out of pocket.
Before Applying for a Mortgage
Want to avoid a denial letter? The best way to is to preemptively prepare before you even begin applying for a home loan. The basics steps for success are:
1. Know Your Credit Score
Request credit reports from all three major credit bureaus, since the information can vary. Work on correcting any inaccuracies or discrepancies between credit reports.
2. Manage Your Debt
If you know you have a high DTI or credit utilization ratio, take time to consolidate payments and credit cards. Be careful not to close all of your cards in an attempt to get your credit score to skyrocket: Having long-term lines of credit is going to make lenders feel much more comfortable than someone who suddenly pays off all of their loans and closes all their accounts.
3. Manage Your Expectations
Don’t set yourself up for failure: Be realistic about how much home you can afford. If you’re working with a modest budget, a custom McMansion isn’t in your future, and any loan applications for outrageous amounts will be denied.
A mortgage loan denial is definitely an obstacle, but it doesn’t have to derail or stop your entire home search process. Take time to evaluate your situation and make conscious steps to improve so when you reapply, you’re a stronger candidate.
Do you have other questions about the home searching, purchasing, or building process? Drop them in the comments below, or head over to NewHomeSource’s Learn Center for more resources.