The prospect of buying a home is an exciting one, but a rejected mortgage application can put a damper on things. Instead of wallowing in despair, look at this situation as a learning experience. Find out why you were denied a mortgage, then take the steps required to make the necessary changes.
If you were turned down for a mortgage, odds are it was because of one of the following reasons.
1. Bad Credit
With a poor credit score, not only will you likely be turned down for a home loan, you’ll likely even be rejected for an apartment and even a job. Your lender will want to know what your credit score is in order to help them determine whether or not you’re a risky investment. Not only is your credit score going to be assessed, so will any negative comments that may be included on your credit report.
Generally speaking, a credit score of less than 620 is considered too low for mortgage approval. If your credit score is the reason for your mortgage application rejection, take steps to improve it. Start by pulling your credit report and identifying any potential errors, paying down your debt, avoiding additional loans, and paying every monthly bill on time and in full.
2. Insufficient Income
You will need to have a certain level of income in order to get approved for a home loan. After all, you will need to be able to afford a mortgage, or else you will surely be denied. You will need to supply documents of your finances and assets along with your income statements, as well as tax returns from the past few years.
A mortgage denial because of insufficient income just might mean that you need to look at homes in a lower price range. Or else, you may just need to work on your career and take the steps necessary to advance it – and eventually make more money.
3. High Debt-to-Income Ratio
Your debt-to-income ratio (DTI) goes hand-in-hand with your income. More specifically, it’s your income compared to all of your debt that will be weighed heavily upon. If it’s too high, you probably won’t be approved for a home loan. In fact, the most common reason for mortgage denial is debt; namely, too much debt compared to how much money you make. Having said that, even if you have enough money to make your mortgage payments, you’ll be viewed as a risky investment in the eyes of your lender if your debt is sky-high.
Lenders calculate both your “front-end” and “back-end” debt-to-income ratios. The front-end ratio uses your gross income and takes into account your new mortgage payment that includes taxes, interest, and insurance. A front-end DTI of 28% or less of your gross monthly income is considered acceptable.
The back-end ratio incorporates your income and all monthly debt payments that you’re responsible for, including your rent, credit card payments, student loan payments, and so forth. A back-end DTI of 34% and under is considered acceptable for conventional mortgages, and even as high as 41% for FHA-backed mortgages.
If your DTI was at the root of being turned down for a mortgage, work to either reduce your debt or raise your income to help bring your debt-to-income ratio down.
4. Short Employment History
You might be making a decent income right now, but if you can’t provide enough evidence of a long track record of consistent employment, your lender may be hesitant to extend a mortgage. The majority of lenders will want you to have at least two years of consistent employment before they approve your home loan.
That’s because they want to be sure that you’re able to keep a job long enough to comfortably repay the money they loaned out to you. If the reason you were turned down for a mortgage is because your employment history is still rather short, you may just need to sit tight and wait until it’s sufficient in the eyes of your lender.
5. Inadequate Down Payment
The down payment goes towards the purchase price of the home. The higher the down payment, the smaller the loan amount required. A high down payment will make your lender feel more confident that you’ll be able to repay your loan. But the opposite is also true: a low down payment will make your lender feel uneasy of approving you for a mortgage.
In general, homebuyers will require a down payment of at least 5% of the total value of a home for a conventional mortgage. However, some government-backed mortgage programs require less, and there are even those that don’t require a down payment at all. However, if it’s a conventional mortgage you’re looking for, a minimum of 5% is necessary. If your skimpy down payment was the cause of your mortgage application getting rejected, start saving now.
6. Low Appraisal on the Property
Once your offer has been accepted by the seller, your lender will send a professional appraiser to the home to assess its market value. If the appraisal comes in a lot less than what you agreed to pay for the home, your loan will likely be denied.
There’s still some hope, however. You can always renegotiate the price of the home with the seller in hopes that they will reduce the price. You can use the information from the appraisal as support for a lower price.
You may also try to come up with the extra money needed to bridge the gap between what your lender will loan you and the actual purchase price of the home. It’s also possible to have the home reappraised by a completely different appraiser in case the one that conducted the initial appraisal made some errors that led to an inaccurate result.
The Bottom Line
If your mortgage application was rejected, don’t fret. While this may be a snag in your homebuying process, you can eventually realize your dream of becoming a homeowner. Identify the reasons that you were turned down and make a valiant effort to turn things around. That way, you can bump up the odds of being accepted the next time.