Have you been denied a mortgage loan recently? Rejections usually don't come down to a single reason, because lenders look at your overall financial status.
However, some factors increase your risk of rejection. According to NerdWallet's 2018 Home Buyer Report, three issues stand out as primary reasons for mortgage denials based on the most recent available data (2016). The top two are fundamental to the Ability-to-Repay rules outlined by the Consumer Financial Protection Bureau (CFPB) in the wake of the financial crisis. The third is more related to the home than the borrower.
1. Debt-to-Income ratio (DTI) – Your DTI ratio is your total monthly debt obligations divided by your gross monthly income. NerdWallet found that 28% of mortgage loans were rejected primarily for a poor DTI, the highest percentage of any factor evaluated.
DTI limits may vary, but the upper limit has generally been in the 43% to 45% range for a loan to be considered safe. "Depending upon your income, that may not necessarily be a danger zone, but just keep in mind lenders are often willing to lend you more money than you may be comfortable borrowing," warns Bankrate.com Chief Financial Analyst Greg McBride. "And ultimately, you're the one that's on the hook for those monthly payments."
The mortgage backer Fannie Mae recently raised the acceptable DTI to 50% based on historical data showing minimal increase in risk – but a DTI ratio near the upper limit requires other mitigating factors to decrease the risk. For example, a high credit score and a solid history of repaying previous debts may tilt a decision in your favor.
Which brings us to...
2. Credit History – If you have handled credit poorly in the past, why would a lender extend credit to you now – especially for the large amounts required for mortgages? Lenders agree, sinking more than 21% of mortgage applications for poor credit histories.
Credit scores in the mid-700s or above will help to secure a mortgage at prime rates. Once your credit score drops to the 620 to 670 range, you are considered higher risk. "You are probably going to get an OK mortgage rate with an OK score," says Experian Director of Public Education Rod Griffin. "You are going to need a good credit score to get a good rate, and that just takes time."
Below that point, your loan offer will be considered subprime. You are more likely to succeed with a non-bank lender that will charge higher interest rates and take other steps to mitigate the risk. If you qualify for an FHA loan (where the loan is backed by the FHA), you may be able to get a loan with a credit score as low as 500 – but other risk factors must be under control.
This drives home the importance of checking your credit history regularly. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips. Check for any errors in your credit report or signs of identity theft such as accounts opened in your name. You could be unfairly rejected due to incorrect information.
3. Collateral/Valuation – Your mortgage is a secured loan, meaning that the value of your home serves as collateral. If you default on payments, the lender can foreclose on your home and recoup the losses. If a lender has an independent appraiser assess the home and the appraiser finds a lower value than the intended mortgage loan, the bank might not be able to reclaim the full value of their loan.
Approximately 17% of mortgage denials in the NerdWallet study were for insufficient collateral. In that situation, you can fill the gap with a higher down payment, negotiate the price down with the seller given the new valuation, start over with a new mortgage loan, or simply back out entirely.
Competition for homes is fierce – so it's important to have your finances and credit situation in the best possible shape. If it's not, consider whether you would be better off stretching your finances and paying higher interest rates or waiting until your finances have improved enough to avoid rejection.
MoneyTips is happy to help you get free mortgage quotes from top lenders.