Waiting for your mortgage to be approved can be a tense time when you’re hoping to buy a home. Unfortunately, some mortgage loans are denied during the underwriting process. Nearly 9% of all applicants were denied a home purchase loan or refinance in 2019, according to data collected under the Home Mortgage Disclosure Act. If you’ve had a mortgage loan denied in underwriting, you may be wondering what’s next.
Understanding what factors lead to denial can help you make a successful mortgage application.
How underwriting works and why underwriters deny loans
The most common reasons that mortgages are denied in underwriting include the applicant’s credit history and the amount of debt and collateral the applicant has. But in one out of 10 denials, the problem was simply that the credit application wasn’t complete.
You may wonder what it means when a loan is in underwriting. During the underwriting process, the lender will analyze all your financial information, such as your credit history and debts, to decide whether you qualify for a mortgage. You’ll have to supply documents such as bank statements and pay stubs to prove you’re eligible for the mortgage.
The lender wants to be sure that you’ll be able to pay back the loan and it won’t be risking its money. Under a law usually called the ability-to-repay rule, lenders are required to consider your income, employment, assets, monthly expenses, and credit history to ensure you can make the payments for your mortgage.
Common reasons an underwriter would deny a loan:
A borrower’s credit profile includes a credit score and debt-to-income ratio, or DTI. Among all mortgage denials, DTI is the most common reason that a buyer is denied a mortgage, accounting for about 30% of all denials.
To calculate your DTI ratio, add up all the debts you’re responsible for each month, such as a car loan and credit card bills. Add the amount of your expected monthly mortgage payment, then divide by your total monthly income. In general, it’s a good idea to keep your DTI ratio under 43%, even though some lenders accept higher ratios up to 50%. With a lower DTI, though, you may have more financial flexibility to repay your mortgage if there’s ever a disruption to your income later on.
Your credit score, which reflects your history of paying your revolving bills and handling your debts, is also part of your profile. For most conventional loans, you need a credit score of at least 620 to qualify.
If your credit record shows missed payments or unpaid loans, the lender will ask you to submit a letter explaining why you missed payments and what you’ve done to resolve the issues. However, if new late payments or past-due loans come to light during underwriting, the loan might be delayed at closing.
Problems with the property
Problems with the property you’re buying can also cause loan issues. For example, if the home appraises for less than the price you agreed to pay, you’ll have to renegotiate the price or make a larger down payment to make up for the difference between the appraised value and contract price. The lender can’t make a mortgage for more than the house is worth, based on the appraisal.
The loan-to-value ratio, or LTV, can be an issue, too. The lender limits the amount of money it will lend you to a certain percentage of the value of the home, and you make up the rest with your down payment. If you don’t have enough money for the required down payment, you may be denied the mortgage.
With some government-backed loans, the house must also pass a safety inspection. If it fails, the loan will be denied.
Changes in your situation
Changing jobs or taking out a loan during the underwriting process may affect your mortgage approval. Lenders want you to have stable employment, and they may be concerned you won’t stick with your new job. If you took a cut in pay, your new income might not qualify you for the mortgage.
Taking on additional debt — such as buying new furniture on credit — can affect your DTI and disqualify you from a mortgage.
What to do when your mortgage is denied near closing
If your mortgage was denied after getting the closing disclosure, you’ll most likely receive a formal rejection letter. You are entitled to receive a written explanation of why the funding was denied, and you can request a letter if you don’t receive one. If the denial was based on your credit score, the lender must provide copies of the score it used.
While having a mortgage loan denied at the last minute is disappointing, it’s important to understand why the loan was denied. When you know the factors that caused the denial, you can develop a plan to fix the problems that disqualified you.
In a few cases, you may be able to save the loan. For example, if you have a new job, you may be able to provide additional documents from your employer, such as a contract showing your salary. If the loan was denied because of a large deposit into your bank account, which the underwriter might interpret as evidence you took out a loan for the down payment, you may be able to provide a paper trail showing where the money came from. If you received money for the down payment as a gift, the underwriter will want a gift letter from the person or organization that gave you the money.
To improve your chances for loan approval, take time to repair the parts of your financial picture that hurt you this time:
- Improve your credit. Paying your bills on time and limiting how much you charge on your credit cards can help bring up your credit score and improve your credit history.
- Improve your DTI. Paying off any debts you can will improve your debt-to-income ratio. Even if you can’t completely pay off your credit card bills, paying down the balance will give you a better DTI. Avoid adding any more debts.
- Look for a more affordable house. Finding a house that costs less can affect your finances in several ways. With a lower price, you need less money for a down payment. Your mortgage will also be lower, so a more affordable house can help your DTI, too.
How to avoid mortgage loan denial at the last minute
Even if you’ve been preapproved for a mortgage, changes in your financial situation can be a roadblock to getting a loan. Communicate with the underwriter about changes before they become a problem. Quickly provide any paperwork the underwriter asks for so that there is no delay in processing your loan.
To limit situations that can trigger a last-minute denial of a mortgage:
- Avoid making big purchases during the loan approval process. Wait to buy furniture for the new house or to take out a car loan until your mortgage has cleared.
- Avoid closing old credit accounts, which can lower your credit score.
- Avoid changing jobs during the closing approval process. If you can’t wait until after closing, notify the underwriter and see what employment documents are necessary for approval.
Mortgage loan underwriting FAQs
How often do underwriters deny loans?
Underwriters deny loans about 9% of the time. The most common reason for denial is that the borrower has too much debt, but even an incomplete loan package can lead to denial.
When can I apply again after my loan application is denied?
Applying for a mortgage is time-consuming. If your loan application was denied, it’s best to fix the issues that led to denial before you reapply. Take steps to improve your credit score, lower your debt-to-income ratio, and save money for a down payment. Once you’ve improved your credit profile, put in a new mortgage application.
What is considered a big purchase during underwriting?
There is no dollar amount threshold for a big purchase in underwriting. Buying an appliance, furniture, or a car on credit can increase your DTI enough to affect your ability to buy a house. The best advice is to wait to purchase anything beyond necessary items until the loan is approved.
As an example. underwriting guidelines for VA loans say any account that requires a payment large enough to “cause a severe impact on the family’s resources” must be considered during underwriting.
Worried about potentially being denied a mortgage loan? Contact a Finance of America Mortgage Advisor today who can help you prepare for the mortgage process.