Today, only four out of ten mortgage applications close. That means 60 percent of prospective home buyers walk away disappointed. For first-time home buyers, that statistic may be even higher. But if your mortgage application is declined, don’t despair. Getting mortgage approval isn’t easy and—like many things worth doing—it may take several tries to get right. After your mortgage application is declined, the first step is to find out why. Once you do, it’s fairly easy to take the steps you need to ready your finances for another go.
There are only so many reasons your mortgage application may be declined. The most common are:
- Your credit score is too low.
- Your monthly debt payments are too high compared to your income.
- You’re applying for “too much house” for your income and assets.
Lenders and brokers want to approve your mortgage (after all, approving mortgages is how they get paid). So if you don’t qualify initially, they should be happy to explain to you why your application was declined. If they don’t offer this information immediately, ask them. Let’s take a closer look at what each reason means and what you can do about it.
Low Credit Score
Because mortgages are secured by property (the house), even people with shaky credit scores sometimes get approved for a mortgage. The lower your credit score, however, the more interest you’ll pay. Therefore, it’s best to get your credit score as high as you can before taking on a home loan. Still, some lenders burned by issuing too many “sub-prime” mortgages have significantly increased the minimum credit requirements needed to qualify for their loans. So it’s possible to be denied a mortgage on the basis of credit score alone.
The primary factors in a low credit score, in order of importance, are:
- Late payments
- Too much debt
- Too little credit history
- Too many inquiries
Late Payments: Paying your bills on time is the single most important thing you can do for your credit score. One 30-day late payment can drop your score by up to 100 points, and it can take one or two years of on-time payments for your score to recover. Miss more than one payment, or fall 60 or 90 days behind, and your score will really plunge. If your mortgage application is turned down for a low credit score due to missed payments, it’s the easiest fix (pay on time going forward). Unfortunately, it’s the fix that will also take the longest. You may just have to wait between 12 and 24 months before applying again.
Too Much Debt: The second most important part of your score is how much debt you have compared to your total credit limits. For example, if you have $5,000 of credit card debt and a total $10,000 credit limit, you’re using 50 percent of your available credit, which may be too high. Try to get this ratio under 20 percent by paying down debt, even if it means taking cash from your savings for a down payment.
Too Little History: The longer your credit file has been open, the higher your score goes. If you’ve only had credit for a year or two, you may need to wait another year or two before getting a mortgage. Similarly, if you only have one or two credit cards on your report, you may need to take out a fixed installment loan (like a car loan or a debt consolidation personal loan), to improve your “credit mix”. Being anti-debt, I hate to recommend taking out credit…but you can always get the loan and pay it off in full within a few months. It will still help your credit. Finally, if you no credit history at all, you have your work cut out for you. Start with a credit card and work on paying on time for one to two years.
Too Many Inquiries: Mortgage lenders don’t want to see that you’ve been trying to apply for any credit you can get in the last few months; it makes them nervous you’ll get a bunch of credit and then fail to make payments. So it’s a good idea to hold off on applying for credit cards or other credit six to 12 months before applying for a mortgage.
If your mortgage application was declined because of a low credit score, spend $15 a month or so for a few months on a credit monitoring service to track your progress. Your lender may even be able to tell you the score you need to qualify, so when you reach it, you know it’s time to reapply for your mortgage.
Even if you have stellar credit, a mortgage lender may turn you down for having a debt-income-ratio that’s too high. This is similar, but not exactly the same, as your credit utilization ratio that figures into your credit score. Your debt-to-income ratio (DTI) all comes down to how much you spend every month on minimum debt payments and how much you earn.
This is where auto loans, or other loans that have a high fixed monthly payment, can hurt. If you earn $3,000 a month and have a $400 a month car payment and two credit cards with a total minimum payment of $100, your DTI is about 17 percent. That’s not terrible; trouble is mortgage lenders add your future mortgage payment on top of that. If you’re looking at a $1,000-a-month mortgage, your DTI just jumped to 50 percent, which is too high. Most lenders want to see this ratio under 45 percent—for the sake of your own financial security, it’s better to get it even lower. Read more about what percentage of your income you can spend on a mortgage.
“Too Much House”
The last big reason your mortgage application could be declined is that you’re simply trying to finance too much for your income and assets. This can be solved in two very straightforward ways:
- Shop for less expensive homes
- Increase your equity (down payment)
If your lender tells you that you’re simply asking for too much, you can always reduce your asking amount. For some—such as those in pricey real estate markets like Northern California or the Northeast Coordinator—that may not be an option. Fortunately, there’s another solution: save more! I recommend home buyers put at least 20 percent down. It gives you equity in your home right off the bat and helps you avoid private mortgage insurance (PMI), which unnecessarily increases your monthly housing payment.
If your mortgage application has been declined, take heart: you’re not alone, and with some work, you can ready your finances to buy a home. Looking to get pre-approved for the first time or a second time? Get mortgage pre-approval online from several lenders at once.