You’re ready to buy a home. And with prices on the rise, you want to make your move before home prices and mortgage rates head too much higher.
You head to the bank and attempt a mortgage pre-approval. But you’re denied. You are furious and embarrassed at the same time. You wonder what went wrong. Now what? Here’s advice from the mortgage experts to get you back in the saddle and qualify for that mortgage.
Denied a mortgage? Find out why
You can’t fix a problem if you don’t know the issue. Luckily, it’s relatively easy to find out what went wrong with your mortgage application.
“The Equal Credit Opportunity Act mandates that all lenders and credit providers tell you the reason for the denial,” said Tino Diaz, senior vice president of Columbus Capital Lending, a multi-state mortgage firm.
The lender should tell you the credit reporting agency’s information used to make the decision. On top of that, your lender can give you more specific information about the denial. Some of the most common reasons for denial, according to Diaz, include:
- Poor credit score
- High debt-to-income ratio
- Job history
As soon as you know the reasoning behind your mortgage loan denial, you can move forward to tackle the problem.
Poor credit score
Start with your credit report, recommended Diaz. A denial of credit entitles you to a free copy of your report from whichever agency the lender used. On top of that, the law requires that each of the three major bureaus provide you with a copy of your report at least once a year. (You can request your free annual reports at AnnualCreditReport.com, a site jointly sponsored by the three largest U.S. credit reporting companies.)
Request your credit report and look through it. Are errors holding you back? For example, when I bought a house in 2007, one of my student loans and one of my then-husband’s credit cards were double-reported. It looked like we had more debt than we did. Once we cleared it up with the credit reporting agency and the mortgage lender, our pre-approval went through.
If your score is low due to past mistakes, take steps to improve your credit ASAP. “Paying bills on time is critical,” said Jennifer Beeston, the vice president of mortgage lending at Guaranteed Rate Mortgage, a company that focuses on matching borrowers with lenders. “If you constantly pay your credit card bills late, then you should get on autopay.”
Beeston also advised looking at your credit utilization — the percentage of your available credit you are currently using. “Generally, I suggest paying all credit cards down to 30 percent of the limit and getting rid of non-medical collections that are recent,” she said.
It can take a few months to see changes to your credit score, but once your score improves, you have a better chance of qualifying for a mortgage down the road.
Answering the question, “how much mortgage can I afford?” starts with figuring out how much of a house payment you can manage. You need to get to the bottom of this after you’re denied a mortgage due to your debt-to-income (DTI) ratio.
Your DTI ratio represents your monthly debt payments as a percentage of your monthly income, and it comes in two types:
- Front-end: Your housing payment in relation to your gross monthly income. “You want to keep this under 42 percent for best results,” said Beeston. So, a monthly income of $3,800 limits your monthly mortgage payment to $1,596.
- Back-end: This measure takes into account your total debt payments plus the potential mortgage payment. As of July 29, housing giant Fannie Mae raised its cap on total DTI to 50 percent. So, for example, your total monthly payments on credit cards, auto loans, student loans, and potential mortgage payments shouldn’t exceed $1,900 if you make $3,800 gross each month.
“If your front-end DTI is the problem, make sure they are using all your income,” said Beeston. “If all your income is being used, you need to choose a less expensive home or wait until you make more money.”
On the other hand, if your back-end DTI is the issue, you might need to pay off some debt. “Sometimes paying off a $3,000 credit card can make the difference between being accepted and denied,” Beeston said.
A bigger down payment or putting more money toward closing costs can also help, said Diaz. When you put more money down, your loan is smaller, so your monthly payment shrinks. If you were planning to roll your closing costs into the loan, it could boost what you owe. Paying closing costs outright can keep your payment under control.
Beeston said lender requirements vary, and some might be stricter, but you’re better off working to keep your DTI lower. Just because someone will give you a loan with a high DTI, it doesn’t mean it’s the best idea. Keeping your front-end DTI below 30 percent makes more financial sense, and it’s always a good idea to pay down as much of your debt as possible.
Time on the job is crucial when it comes to mortgage approval, said Beeston. And if the bulk of your income is commission-based and you just started receiving that commission, that could be a problem.
Beeston suggested asking the lender what they expect. Once you meet their underwriting requirements for time on the job (and everything else is in order), you can re-apply.
You might also run into issues if you are self-employed. When I bought that home in 2007, most of the income came from my freelancing business. I was denied a mortgage until I agreed to an income audit for the previous two years. Once the lender verified my income and deemed it reasonably stable, I was approved.
Get a second opinion
Once you have an idea of what your lender’s underwriting department doesn’t like about your loan application, it’s possible to get a second opinion. “Some lenders have divisions whose sole purpose is to re-evaluate loan applications,” said Diaz. “Ask if they can review your application and make a new ruling.”
On top of that, Diaz noted that lenders have different approval standards. Just because one has denied you a mortgage due to, say, a 650 credit score, doesn’t mean all lenders will reject your application. Shop around to see if someone else is willing to give you a loan.
You can even turn to non-traditional funding, such as hard-money loans. “I work with multiple investors, as well as selling direct and brokering,” said Beeston. Some investors are willing to take on risks that more conventional lenders aren’t. “With one loan scenario, I may have three lenders that will do it, and four that won’t. Options are critical.”
However, if you take an untraditional route, or get a mortgage when your credit score is low, you could wind up with a significantly higher interest rate, Beeston warned. Weigh your options. Maybe it makes more sense to work on your problem areas and reapply after your situation has improved.
Even if you’re denied a mortgage today, it’s not the end of your dream of homeownership. Once you know the reason for the denial, you know what to fix to improve your chances for next time.