What You’ll Learn
Common reasons why a lender would deny a home loan application
How to improve your chances of being approved
What your options are
You’re ready to buy a home, but your lender may not agree. Maybe you’ve got a mortgage that you’re looking to refinance, but your lender won’t approve the new loan. If you find yourself in one of these situations, you’re not alone: 1 in 8 home loan applicants have their loan denied. According to Home Mortgage Disclosure Act data, 15% of mortgage applications for new homes were denied in 2018. That number skyrockets to 34% when you include applications for home improvement loans, interest-rate reduction loans, and cash-out refinance loans. The reason why a mortgage loan application is denied depends on whether you’re in the pre-approval stage or the loan application stage. The key difference between the two is based on documentation you’ve provided.
A pre-approval is generally based on self-reported information about your property, income, assets, and a soft credit check (which won’t affect your credit score). Pre-approvals are typically denied based on one of two factors: too much debt (37% of denied loans) or low credit scores (34% of denied loans). Insufficient credit could also lead to a denial.
The loan application stage comes after you’ve been pre-approved, put an offer on a new home, paid an earnest money deposit, and now need the official go-ahead to get that home. It also comes after pre-approval for refinancing. In both cases this is when you need to submit supporting documentation for the lender’s underwriter to review. During this stage of a loan application, lending experts take an in-depth look at your overall financial picture and the documentation you provided. If something doesn't align with the home loan you are applying for, the loan won’t be approved.
Although being denied a home loan can be disheartening, it doesn’t mean the end of your homeownership journey. You still have options.
When a lender denies a home loan application they’ll send a letter explaining why they couldn’t approve the loan. Often these letters include the specific reasons that led them to their decision, but if the letter isn’t clear, by law the lender must tell you that you’ve got the right to request the reasons why your loan was denied if you ask within 60 days.
Here you’ll find the most common reasons mortgage loan applications are denied, why they matter, and the actions you can take:
High debt-to-income ratio
A high debt-to-income (DTI) ratio is the number one reason mortgage loan applications are denied. Before approving a home loan, lenders want to be sure you can financially handle additional debt. Your DTI ratio shows how much monthly debt you are paying back compared to your gross (pre-tax) income. Most mortgage lenders can offer loans to creditworthy borrowers with DTIs as high as 43%. However, some lenders (including Better Mortgage) can offer loans to people with DTIs up to 50%, provided the borrower has good credit. High DTIs can mean you are over extending yourself on your financial obligations, which could lead to late payments and credit score dings.
How to lower your DTI ratio:
- Work to pay off debts on credit cards and other high-interest loans. By reducing your outstanding balances, you’ll free up more room in your budget for a new mortgage payment.
- Pay off your car and other large loans to lower your DTI ratio. And postpone large purchases (such as a new car) and/or taking on more debt until after your mortgage loan is secured.
- Boost your income. Consider negotiating for a raise or start a side hustle. If your income increases, the difference between your income and debt will improve.
Poor credit score
Credit scores help lenders gauge your ability and willingness to pay back your debts on time. A low score may indicate that you’ve had trouble making debt payments on time and managing other debts, and that you may be less likely to make future mortgage payments on time. At Better Mortgage, we can provide loans to customers with a credit score of 620 or higher—so long as other factors, like debt-to-income ratio, have been satisfied.
How to increase your credit score:
- Boost your score by making timely payments on all your lines of credit. On-time payments are the most significant contributor to a good credit score.
- Keep the balance on credit cards below 30% of your available limit. How much debt you have compared to your total available credit is another major factor that impacts your score: the lower your outstanding balances, the better your credit score.
- Check your credit report and dispute any errors. Incorrect or fraudulent credit accounts on your report can decrease your score. By disputing errors, any associated credit dings would be removed.
Having limited credit history also has its challenges. Younger, first-time homebuyers or those with minimal or no credit history are most likely to come up against this issue. Lenders want to have a good idea of how you manage your money which is why they want to see a proven history of paying off debts.
How to increase your credit history:
- Seek ways to build your credit history. Making consecutive on-time payments is the most straightforward way to boost your score, but speaking to a lender or bank can help you find additional ways to address your unique situation.
- Consider asking a spouse or relative with good, established credit to add you as an authorized user on a credit card. The positive history from their account will be reflected on your credit profile, which in turn, will help lengthen your credit history.
- Make sure you’re listed as a borrower on any student loans or car loans you have. On-time payments of these types of accounts is another great way to build your credit.
Not enough cash to close
There’s more to a home loan than the monthly payments. Buyers will need to prove that they can cover the down payment and closing costs to be approved for a mortgage. Most lenders require buyers to be ready with a down payment of at least 3%–5% of the home’s purchase price, plus have money set aside for closing costs which are usually 2%–5% of your loan amount. Refinance borrowers also need to pay closing costs. If your bank statements or savings show that you don’t have enough money to cover all the necessary costs, the loan would be denied and you won’t be able to close on the home.
How to get enough cash to close:
- Consider borrowing from a retirement account. Speak to your financial advisor to learn how this action can impact your future goals and if you’re eligible to take this step. If it works for you, you’ll need to provide documentation that you’re qualified to borrow or withdraw from the account.
- Explore down payment assistance (DPA) programs. These programs are commonly run by state or local governments or nonprofit organizations, and are often available to first-time or lower-income borrowers. Some DPA programs offer grants which do not need to be paid back, but others offer assistance in the form of a loan. Make sure you understand the repayment expectations before applying.
- Calculate approximately how much you’ll need for a down payment and closing costs then continue to save aggressively to cover those costs. Alternatively, you could lower your maximum budget for a new home to ensure the savings you currently have are enough to cover your downpayment and closing costs.
Unstable work history
Lenders like stability—in your debt payments, in your income, and, yes, in your job. While switching jobs for a better salary, new location, or different company won’t necessarily hurt your ability to qualify for a mortgage, too much jumping around within the past few years could signal instability and be construed as a red flag.
Generally, lenders like to see that you’ve been with the same employer, or at least within the same industry, for a minimum of two years. If you’re self-employed, lenders generally like to see two years of stable income and will usually request tax returns to verify your income.
Stability in your job history can give lenders—and you—more confidence in your job security. After all, a steady salary will allow you to make your mortgage payments now and in the future.
How to demonstrate stable work history:
- Submit your offer letter and/or several recent pay stubs.
- Provide income documentation that goes back several years to show longer employment periods if your most recent two years of employment aren’t steady.
- If you’re self-employed, document your income carefully to demonstrate a consistent work history. Make sure the average income claimed on your application is reflected in your tax returns.
Unexplained cash deposits
To a lender, not all cash is king. Unexplained cash deposits raise red flags because lenders want to ensure income and assets are from legitimate sources. If your down payment or other assets you’re using to qualify for a loan have been in a bank account in your name for a minimum of 60 days, lenders consider these deposits “seasoned” and they’re no cause for concern. When a lender sees more recent out-of-the-ordinary cash deposits in a banking account they may question whether it was a gift or something you need to pay back. If the money needs to be paid back it will be counted toward your DTI ratio. Without a valid reason for unexplained income such as large or irregular deposits, your home loan could be denied.
How to explain large cash deposits:
- Be ready to submit documentation for any cash deposits that were made to your accounts within the last 60 days.
- Provide a signed gift letter for large cash gifts from a relative or friend. Your lender should be able to give you a template to make it easier for your family or friend to explain the deposit in writing.
- Submit documentation that proves you aren’t expected to pay back any cash windfall or lump sum deposits such as lottery wins or inheritance money.
Missing or omitted application information
With enough money on the line to purchase a home, it should come as no surprise that the underwriters who verify the information you provide are going to dot all the i’s and cross all the t’s. If a field in a mortgage application hasn’t been completed or necessary documentation is missing, it’s going to be a problem. Your loan processor will work with you to ensure the application forms have been completed correctly and they’ll let you know if the underwriter needs more supporting documentation.
How to provide all the information lenders need:
- Double-check your application for missing zeroes or other typos.
- Ask your lender what information and documentation they need before finalizing your application so nothing important is left out.
- Maintain discussions with your lender and your real estate agent if you’re having difficulty providing documentation they’ve requested. They may be able to give you more time so that the loan approval is delayed instead of denied.
What to do when you’ve taken all those actions and the home loan still isn’t approved?
The mortgage process is complicated. A home loan could be denied with one lender and approved with another. Sometimes a loan may be approved, but the loan terms don’t work for you. When you’ve made an offer on a home and the clock is ticking, now is the time to explore all your options.
Actions you can take:
- Ask your realtor for lender recommendations. Most realtors know local mortgage brokers who can help connect you with a loan product within your means. Smaller, local, or private lenders may be less conservative than bigger banks and financial institutions which means they could have a little more wiggle room to approve borrowers with different financial backgrounds. Larger lenders, on the other hand, tend to have stricter, more streamlined requirements.
- Consider adding a co-borrower to your home loan. When you apply with a co-borrower, their income, assets, and credit history will be considered in addition to yours. Your combined financial profiles can help make qualifying for a mortgage easier. Keep in mind that adding a co-borrower means you are both equally responsible for mortgage payments and typically share ownership of the home.
- Apply for government-backed loans, which may offer special programs with less stringent qualifying guidelines and low or no down payment options. Keep in mind that government loans have their own specific qualifying criteria and may not be available to all borrowers. Some loans may only be open to first-time buyers, buyers with lower incomes, or buyers in certain locations.
You can always re-apply for a home loan
There’s no amount of time you need to wait before you can re-apply with the same lender that denied you the first time. That said, if the loan was denied at the pre-approval stage or because you didn’t have enough cash to close, it may take some time to address those issues. Your loan consultant will be able to give you insights into what options are available and next steps you can take. Before you re-apply, bolster your credit score, pay off outstanding debts, and focus on improving your financial situation to make your next loan application more enticing to lenders.
A mortgage is an expensive and long-term decision, so if getting a home loan is too risky for your current financial situation, waiting until your financial situation has changed will be a smart move in the long run. With Better Mortgage, you’ll have a partner to walk you through your options and help you make the best financial decision for you and your family.