Mortgage Rejection and How to Avoid It
It can be discouraging. You do all of your homework to learn about the mortgage process, and then you fill out an application for a loan. But later, the lender tells you that you've been turned down for one reason or another. This is known as mortgage rejection, and it happens to thousands of would-be homebuyers every year.
So why do people get turned down for home loans in the first place? What are the leading causes of mortgage rejection in the current economy? Those are some of the questions we will address in this article for first-time homebuyers. By understanding the reasons people get rejected for mortgage loans, you can take proactive steps to avoid having your own application denied by lender.
Reasons for Mortgage Loan Rejection
There are many different reasons why a potential borrower could be turned down for a mortgage loan. But it usually comes down to one of four things. Here are the four most common reasons people have their loan applications rejected by lenders:
- The borrower's credit score is too low.
- The borrower has too much debt.
- They borrower is asking for too much money, relative to income.
- The borrower lacks a down payment.
Some of these things tend to overlap. For example, having too much debt relative to your income (item #2) can actually lower your credit score (item #1). But I'm going to talk about these factors individually, because each one of them can lead to mortgage loan rejection.
Reason #1 - The Borrower's Credit Score Is Too Low
When you submit an application for a home loan, the lender will review every aspect of your financial background. This includes your credit score. In particular, they will review your FICO score, which is a number between 300 and 850. The lower your score, the less likely you will be to have your mortgage application approved. On the other hand, a higher score will increase your chances of getting a loan. Not only that, but you'll be able to qualify for a better interest rate when you have a good FICO score in your favor.
The trouble is, many Americans have bad credit. And it's one of the most common reasons people have their mortgage applications denied by lenders.
How to fix it: Credit scores are not as complicated as many people think. In truth, there are only a handful of primary factors that influence your score, so it's no secret how to improve a bad credit situation. The first step is to figure out where you stand in the first place. In order to do that, you must request your scores from all three credit-reporting companies. If you find out that your credit is bad, you should focus on improving it before you start submitting applications to lenders.
Reason #2 - The Borrower Has To Much Debt
When you apply for a home loan, you are essentially taking on a greater level of debt than what you currently have. So if the lender compares your current debt to your income level, and determines that you have too much debt already, there's a good chance you will have your mortgage application rejected by that lender. Once again, this is something that affects many Americans, because we are a debt-loving nation. That's what makes this another common reason for mortgage rejection in the current economy.
How to fix it: The solution for this particular problem is fairly obvious. If the lender rejects your mortgage application because they think you're carrying too much debt, you simply have to pay down your debt as much as possible. Once you do that, you can submit another application, and you'll have a better chance of getting approved.
Reason #3 - The Borrower Can't Afford the Mortgage
This is another one of the common reasons for mortgage rejection, but it's also one of the most avoidable. This problem occurs when somebody applies for a loan that is simply too big for them, based on their current income. Most lenders have a rule of thumb that pertains to your required income level, as compared to the loan amount you are seeking.
How to fix it: The easiest way to avoid this problem altogether is by establishing a realistic home-buying budget. In other words, you should figure out what you can realistically afford to pay toward your mortgage each month, and you should stay within those parameters when you apply for a loan.
Reason #4 - The Borrower Lacks a Down Payment
During the height of the housing boom, it was pretty easy to get a home loan with no down payment. Lenders were willing to offer 100% financing to borrowers in certain scenarios. But those days are over. That kind of financing carries a lot of risk, and most lenders today (post-recession) are simply not willing to take such risks. So you will have to bring some amount of money to the table in the form of a down payment.
If you don't have a lot of money to put down on the purchase of a new home, you might want to look into FHA loans. Generally speaking, you can get approved for one of these loans with a smaller down payment than a traditional, non-FHA loan. With a regular loan, you'll probably have to put down at least 10%, and for an FHA loan you will probably need a 3.5% down payment. If you can't meet either of these numbers, your mortgage application could be rejected by the lender.
How to fix it: Like all of the mortgage approval problems we've discussed so far, this one has an easy solution. You simply need to save up enough money for a down payment, based on the type of mortgage loan you're seeking. That's why I tell first-time homebuyers to start saving money early on in the home buying process. You need enough money for a down payment, but you'll also need sufficient cash to cover your closing costs. So start saving early, and save as much as you can.
These are some of the most common reasons for mortgage rejection, and what you can do to avoid having your application turned down by lenders. If you would like to learn more about any of the topics discussed above, follow the hyperlinks provided within the article or use the search tool at the top of this website.