There’s no doubt, with the mortgage debacle and ensuing recession, that mortgage lending practices are much more rigid and home loans are not nearly as easy to qualify for as they were in the mortgage heyday prior to 2008. However, even with tighter lending restrictions, there’s never been a better time to buy a home — especially with mortgage rates being at all time lows.
But what do you do if you’ve been denied? If you’ve applied for a mortgage and were denied, it’s important to understand why you were denied so that you can address the issues before attempting to reapply. Here are the top three reasons why you may have been denied a mortgage, and what you need to know in order to correct them before your next mortgage application.
1. Debt-to-Income Ratio
Debt-to-income ratio is the percentage of your monthly gross (pre-tax) income that is (or will be) devoted to servicing your monthly debt payments. Typically lenders want to see that you are obligated to pay no more than 38% of your monthly income toward your debt. Lenders will show some flexibility —up to a maximum of 45% —if you have offsetting factors such as: excellent credit, demonstrated ability to accumulate savings, or a high level of equity in your house.
Consumers can improve their chances of approval by knowing where they stand by calculating their own debt to income ratios beforehand. If the debt-to-income ratios exceed 38%, it might be wise to consider ways to eliminate excess debt to reduce the ratio to acceptable levels before applying for a mortgage. It is important that this step be taken prior to applying for the mortgage because some lenders may not allow monthly payments to be eliminated debt once an application has been received.
2. Poor Credit History
Poor credit history is another common reason that consumers are denied for a mortgage. There are several aspects that almost all lenders consider in their decision to approve a loan including: minimum credit score and presence of significant derogatory credit items. Today almost all lenders will consider a FICO score of less than 620 to be too low to qualify for a mortgage. And depending on the individual circumstances and the equity in the property, that number could be even higher. Serious derogatory credit, such as a bankruptcy or foreclosure, typically require a period of reestablished credit—typically four to seven years, before a bank will consider a borrower eligible for a mortgage. Other serious derogatory items, such as accounts that are charged off or in collections, are generally required to be paid prior to the loan closing.
It is important for consumers to know where they stand in regards to their credit before applying for a mortgage. Consumers today benefit from unprecedented transparency into their credit information. There are numerous free or low-cost resources for consumers to research their credit history and credit scores. For example, there’s the federally mandated website, www.annualcreditreport.com that provides all three credit report cards from Equifax, Experian and TransUnion— free, once a year. And I’d be remiss if I didn’t mention the amazing resource the folks here at CreditSesame have created to provide your free credit score with free monthly score updates, too. Once you have your report, you will also want to ask yourself a tough question: what is an excellent credit score in today’s market, and how can I get there to improve my mortgage rates?
While credit reports are generally accurate, the majority of credit reports typically do have errors. While these errors may not cause you to be denied, they could easily cause you to pay more for your mortgage than you should simply because mortgage pricing is almost always tied to your credit score. Given the importance of credit, consumers should dispute inaccurate information but be aware that it can take up to 60 days for the errors to be corrected or removed from your credit reports. The key here is to perform the research before applying for the loan so there are no surprises.
3. Insufficient Collateral
The amount that a bank is willing to lend on your property depends on the value of your property. If you have too little equity in your property, your lender may ask you to either reduce your loan, which would require you to come up with more money, or deny your loan entirely. The value of your property is determined by an appraiser, who will inspect your property and develop a report that takes into account sales data from your neighborhood to determine a reasonable property value. With recent tightening of lending standards, appraisers tend to be more conservative with their property value estimates, which can impact your qualification for the loan that you want.
For refinances, consumers should take some time to walk around their house and make a list of needed repair items in advance of appraiser inspection. It’s also a good idea to make sure that the house is clean and accessible. A poorly presented home can make the difference between approval and denial. Consumers also can make use of various free resources available on the Internet to get an estimate of the value of their house. While these sites do not provide an appraisal, they can give important insight into what the recent sales data is saying about your property.
Before You Apply
In the financial industry you’ll often hear the saying “do your due diligence,” especially when it comes to signing a contract or making a large purchase. In terms of applying for a mortgage, this means doing your homework and familiarizing yourself with general options and terms – before you apply. Unfortunately, consumers often rely too heavily on the professionals handling their loans to research the best options for them. The reality is that there is no lender that offers every mortgage product available. Many lenders, for example, do not even offer commonplace products such as FHA or VA loans, second mortgages or home equity lines of credit and/or super jumbo loans – loans for very large loan amounts. While you can expect a lender to provide you their advice on the best loan option for your situation, they may not offer the loan or loans that are best suited for you. In addition, in some cases “outside-the-box” thinking is required to come up with the best solution. Unfortunately, you should not assume that your bank will be an expert putting a complex deal together.
Consumers are wise to familiarize themselves with general mortgage lending standards and research the areas where their situation might fall outside of typically accepted tolerances. Thankfully, there are a plethora of resources on the web for consumers to research lender guidelines and pricing. Consumer discussion boards can also be a great tool to research how other consumers have solved their mortgage dilemmas.