3 Leading Reasons Mortgage Applications Are Denied
After the financial crisis of 2008, getting approved for a mortgage became much more difficult. Ten years later, lenders have started relaxing lending standards again. However, millions of Americans still get denied when they apply for a mortgage. LendingTree (which owns MagnifyMoney, where I work) analyzed over ten million mortgage applications from the FFIEC (a government agency) to determine the leading reasons for denial – and what you can do to improve your chances.
1. Debt-to-Income Ratio (26% of rejections)
The debt-to-income ratio, frequently called the “DTI,” measures your monthly payments as a percentage of your gross monthly income. For example, if you make $5,000 a month (gross) and have total monthly expenditures of $3,000, you would have a DTI of 60% (= 3,000 / 5,000). Recurring monthly payments are typically included in the calculation. Your new mortgage payment (including escrow for property tax and insurance), car payments, student loan payments and credit card payments would be included in the calculation.
Historically, most lenders want a DTI of 45% or less, and LendingTree’s analysis demonstrated that 26% of mortgage denials were a result of having a DTI that is too high. There are many ways to reduce the DTI. First, consider a smaller mortgage. That might mean you should consider buying a smaller home or waiting longer (to save a larger down payment).
Fannie Mae has recently increased (for some borrowers) the maximum DTI to 50%. But borrowers need to remember the lessons of 2008. Just because a lender thinks you can afford the loan, doesn’t mean you should sign on the dotted line. If 50% of your monthly gross income goes to fixed monthly payments, you will have limited flexibility in an economic downturn.
2. Credit History (26% of rejections)
As part of a mortgage application, lenders will review your credit history (via the credit reporting agencies) and your credit score. The credit scores used for most mortgages might surprise you: typically, banks use older versions of the FICO score. Free credit score sites do not actually provide you with the specific version used by Fannie Mae and Freddie Mac. If you are worried, you can purchase the scores used in most mortgage decisions at myFICO for $59.85. That is a steep price to pay for a credit score. Most free credit score sites provide you with your VantageScore, which is an excellent approximation of the FICO used in mortgages. However, if your score is borderline, you might want to look at your FICO before proceeding.
In addition to your credit score, lenders will want to ensure that you have enough credit history. You could have an excellent score but only have one secured credit card open for 18 months. Each lender is different, but most will want a minimum number of tradelines and a minimum number of years with a credit file.
If your score falls short, you can use a free estimator from myFICO to see what changes in your behavior will do to your score.
3. Collateral (17% of rejections)
You might be willing to pay $300,000 for your new home. But if the bank doesn’t think the home is worth $300,000 you won’t be able to get a loan. Most mortgage lenders will hire an appraisal company to perform an independent appraisal. The appraiser will typically examine the interior of the property and study recent comparable sales. The appraisal protects you as much as it protects the bank: this is an excellent way to ensure you are not paying too much for your home.
Fortunately, there are many tools available so that you can perform some of the same analysis. Use sites like Zillow or Realtor.com to review comparable sales. Don’t rely upon the estimated values of the home. But you can search the database to review recent comparable sales. And be careful if a bidding war starts on the home of your dreams. Before you start bidding, set a maximum amount that you would be willing to pay, and walk away if the bidding gets too high. Although it is difficult to walk away from a home you love, there will be more available and a good realtor will be willing to work with you and wait.
Nick Clements is the Co-Founder of MagnifyMoney.com, a personal finance website that was acquired by LendingTree in 2017.