Getting denied for a mortgage loan 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 homebuying plans.
How Often Does an Underwriter Deny 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 denial rate than others. Here’s how it breaks down.
- Federal Housing Administration loans: 14.1% denial rate.
- Jumbo loans: 11% denial rate.
- Conventional conforming loans: 7.6% denial rate.
- Refinance loans: 13.2% denial rate.
Mortgage denials can also vary significantly 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 with 9.7% for Asian applicants and 6.9% for white applicants.
Reasons Why an Underwriter Denied Your Mortgage Loan
Why would an underwriter deny a loan? “There can be many different reasons a loan is not approved, ranging from not being able to show enough income to repay the loan, to not having an acceptable credit history or even the property not appraising at the anticipated value,” says Doug Perry, strategic financing advisor at Real Estate Bees.
Knowing these potential reasons can help you not only know what to do if your application is denied, but also what to do to avoid denial in the first place:
- Low credit score. Different loan programs have different credit score requirements. For example, a conventional loan typically requires a 620 score, but you may be able to get an FHA loan with a 580 score or even a 500 score if you have a high enough down payment.
- High debt-to-income ratio. You typically need a debt-to-income ratio of 43% or lower – that means your total debt payments, including your proposed mortgage costs, make up 43% of your monthly gross income – but some loan programs can go as high as 50%. “A high DTI tells lenders you might be getting in over your head and are more likely to default,” says Mayer Dallal, managing director at mortgage lender MBANC.
- Low appraisal value. If the home appraisal comes back much lower than the sales price of the home, the loan-to-value ratio, calculated by dividing the loan amount by the value of the home, may be too high for the lender. If the LTV exceeds 100%, the lender may not recoup the loan value if you end up defaulting on the loan or the value of the property declines.
- Other issues with the property. Certain 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 view the property as a bad investment and deny your application.
- Not enough eligible funds for a down payment or closing costs. While you can finance most of the purchase price of the home, most loan programs require that you put some money down using eligible funds – you can use personal savings, proceeds from the sale of your existing home or a gift, but you can’t use things like a personal loan or credit card cash advance. And while you can typically roll 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 requirement for a loan program, the lender may 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 a recent bankruptcy, foreclosure or late mortgage payments.
- Recent change in employment. A mortgage is a significant financial commitment, so lenders prioritize financial stability. If you’ve recently lost your job or you’ve switched to self-employment, it could be cause for concern. The same goes if you switch to a new job in a different field. However, if you changed jobs and are still in the same line of work, this shouldn’t be an issue.
What to Do if Your Mortgage Loan Is Denied
Depending on the reason for denial, there may be one or more issues that you need to address. “If a borrower has been turned down, it is important they understand why, which the lender will document in writing,” says Perry. “That way, they can explain what the issue is when they are seeking a new lender.”
“If you’ve been denied by a big bank for something beyond just poor credit,” says Dallal, “try to explain all of your issues to a smaller lender, and they can often give you service tailored to your individual needs.”
In some cases, you may be able to apply with a different lender and get the results you want. Before you proceed with this, however, look at the denial reason and consider taking time to address it anyway. Even if you can get approved by another lender, taking steps to improve your creditworthiness can help you obtain more favorable terms.
With that in mind, it’s important to note that there’s nothing to be embarrassed about if your loan is denied. Mortgage lenders work in hard numbers, and it’s not an indictment of your character. While some issues may take longer to resolve than others, there can still be a clear path toward homeownership. 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 house and take steps to address any issues that could be pulling your score down. You can start by getting a copy of your credit report and reviewing it for negative items. Potential steps include paying down credit card debt, paying off a loan and disputing inaccurate information.
- Reduce your DTI. There are only two levers you can pull with DTI: debt payments and income. Unfortunately, starting a side hustle to earn more income won’t help much, as lenders typically require two years’ worth of self-employment income. However, if you can find a higher-paying job, that can help. Alternatively, you could look for opportunities to lower your debt payments by paying off smaller balances or refinancing debts with a longer repayment term. Just keep in mind that the latter option may increase your total interest charges on those debts.
- Make a lower offer. If the appraisal value of the home comes in much lower than the sales price, the seller may be forced to take a lower offer, as other potential buyers may have just as hard a time getting approved for a loan with a lower appraised value.
- Make a larger down payment. If homes in your area are going for more than they’re appraised for, you may not be able to get by with a lower offer. Instead, you may offer to put down more money to lower the LTV enough to meet the lender’s standards.
- Consider a different home. If you can’t make the math work with the appraised value versus the sales price, your DTI is too high for the amount you want to borrow, or the home doesn’t meet the requirements for your loan program, you may need to keep house shopping to find a better fit for your needs.
- Save more money. If you don’t have enough cash in reserve to cover the down payment and closing costs, it may make sense to wait and save more money.
- Get a loan with no down payment requirement. If you’re a first-time homebuyer or you qualify for a Veterans Affairs loan or U.S. Department of Agriculture loan, you may be able to get a mortgage with no down payment requirement. Just keep in mind that if the value of your home drops, you may end up underwater on your mortgage.
- Apply for a down payment assistance program. If you’re a first-time homebuyer or you have low to moderate income, you may be eligible for a down payment assistance program, which can help you meet the lender’s requirements for the down payment and closing costs.
- Ask someone to co-sign. If your financial or credit situation is the problem, you may be able to get approved if you have someone co-sign your loan application. Just be sure that person can meet the lender’s eligibility requirements and understands responsibilities of a co-signer.
- Be patient. If you’ve been denied because of a change in employment or major negative items on your credit reports, you may simply need to wait until you no longer pose a risk to prospective lenders. Consult with a mortgage professional to get a better idea of how long you should wait and what you can do in the meantime to prepare yourself.
How to Avoid Denial in the First Place
Getting a mortgage loan is a big decision, so it’s critical that you prepare your finances and credit file far in advance of your application. Here are some tips to help you maximize your chances of getting approved:
- Review your credit score and credit reports and address potential issues.
- Determine your budget for a home, including the monthly payment and total amount borrowed.
- Calculate your DTI and make adjustments if necessary. Don’t forget property taxes, homeowners insurance and mortgage insurance in your calculations.
- Save enough to meet the down payment and closing cost requirements and still have money left over for emergencies and other unexpected expenses.
- Avoid applying for any other loans or credit cards six to 12 months before your mortgage loan application, as well as during the mortgage process.
- Apply with multiple 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 won’t guarantee approval, they can help improve your odds of getting approved and securing a low interest rate.