You don’t have enough money to put down. You have too much debt in relation to your income. Your credit score is shot.
Those are the three most likely reasons you’ll be denied for a mortgage in 2011, according to a New York Times analysis published in June.
They reviewed mortgage-application trends from 2010, pulling data from ten of the largest lenders in the United States. The focus was on mortgage applications and denials, in particular. According to the study, 26.8 percent of mortgage applications were denied by lenders in 2010. This was the denial rate for all applications, including both purchase and refinance loans.
Rejection rates were higher on the refinancing side, with 27.2 percent of applicants being shot down. On the purchasing side, 19.9 percent of mortgage applications were denied.
Both of these numbers marked an increase over the previous year. In other words, it was harder to get approved for a mortgage in 2010 than in 2009. Will the trend continue for 2011? Time will tell. In the meantime, here are some things you should know about the common reasons for mortgage denial.
1. Your Down Payment is Too Small (or Nonexistent)
If you don’t have enough money to put down as collateral, you will be denied by the mortgage lender. This was the most common reason for application denial in 2010. This factor only applies to people who are buying a home (it’s not applicable for refinancing applications). So for the 19.9 percent of home buyers who were denied for a mortgage loan in 2010, this was the number-one reason. They lacked down-payment funds.
Lenders today are less willing to “over invest” in properties. They want borrowers to have more skin in the game. Unless you’re using a VA or USDA loan to buy a house, you will have to make a down payment of some kind.
For an FHA home loan, you’ll have to put down at least 3.5 percent of the purchase price. For a conventional loan, you’ll need a down payment of at least 5 percent. In some parts of the country, where lenders are more strict, you’ll need to put down at least 10 percent for a conventional mortgage.
Daniel Indiviglio, an associate editor for The Atlantic, recently wrote that “banks will likely require a bigger down payment [than in the past]. They might even demand a higher interest rate, if they worry about the risk you pose as a borrower.”
The solution: This is the most common reason why mortgages were denied in 2010 — for purchase loans, at least. This shows that a lot of would-be home buyers aren’t saving enough money for a down payment. The solution here is simple. Start saving money as early as possible. You’ll need it for the down payment, obviously. But you’ll also need sufficient funds to cover your closing costs and other home-buying expenses. Your lender might require you to have additional cash reserves, as well (explained below).
2. You Have Too Much Debt to Take On a Mortgage
Of the three items on the list, this one probably surprises borrowers the most. Everyone has heard about credit scores, and most people understand the concept of a down payment. But the debt-to-income ratio is less talked about. So it often catches borrowers off guard. That’s probably why it leads to so many mortgages being denied — people have never heard of it before.
Consider this an introduction to the all-important DTI ratio.
Your debt-to-income (or DTI) ratio compares the amount of money you earn to the amount you spend toward debt obligations. A person who spends one-third of his income on the various debts he owes has a debt-to-income ratio of about 33 percent. Someone who spends half the income on debts has a DTI ratio of 50 percent. You get the picture.
You actually have two different ratios, and both of them can result in your being denied for a mortgage loan:
- Your front-end ratio (also referred to as the “housing debt ratio”) measures the percentage of your income that goes toward your housing costs. For a home buyer, the housing cost would come from the total mortgage payment including taxes and insurance. Most lenders prefer this ratio to be below 29 percent.
- Your back-end ratio (also referred to as your “overall debt ratio”) includes your housing costs as well as your other recurring debts. This would include credit card payments, car loan payments, etc. Most lenders prefer this number to be below 41 percent.
The solution: If you’re carrying too much debt in relation to your income, you could be denied a mortgage loan. The solution here is simple, though it does require some discipline. Check your DTI ratio to see where you stand, and then consider reducing your debts if necessary. Do a Google search for debt-to-income ratio calculator, and you’ll find some helpful tools you can use.
You could also get pre-approved by a lender to see where you stand. They’ll tell you if your ratios are too high, and what you can do about it. For example, they might give you a conditional approval if you can pay off a certain credit card balance.
3. Your Credit Score is Too Low
This is another common reason why mortgage applications get denied. When you apply for a loan, the lender will check your credit score to see how you have repaid your debts in the past. Most lenders use the FICO scoring model, which is a three-digit number ranging from 300 to 850. A lower number suggests a history of credit problems (late payments, charge-offs, debt collections, etc.). A higher number suggests a pattern of responsible borrowing.
So a higher score increases your chances of approval, while a lower score increases your chances of being denied for a mortgage.
Most lenders today want to see a FICO credit score of 640 or higher, for a conventional mortgage loan. If you use the FHA loan program, you might be able to get approved with a score below this range.
Carolyn Jordan, an executive with Dallas-based Neighborhood Credit Union, said that a FICO credit score of 720 or higher will help you qualify for the lowest mortgage rates. If your score falls between 600 and 700, you’ll get a less favorable rate but may still get approved for the loan. According to Jordan, “anything less than 600 is not a good thing.” In this context, that means being denied for a mortgage loan.
The solution: There are five categories of information that determine your FICO score. The three most important factors are (A) your payment history on credit accounts, (B) the amount of credit you are currently using, and (C) the length of your credit history. There’s not much you can do about the third item. But you can certainly improve the first two items on the list. You can pay all of your bills on time, and you can reduce your credit card balances.
Other Reasons for Being Denied a Mortgage
We’ve covered the three most common reasons for being denied a mortgage loan (according to the New York Times study). But those certainly aren’t the only obstacles you’ll face when applying for a mortgage. Here are some other things that can send the train off the tracks.
Cash Reserves: Some mortgage lenders will require you to have additional money in the bank, beyond what is needed for your down payment and closing costs. These are known as cash reserves. The idea is that you are less of a risk for the lender if you’ve got a few months worth of mortgage payments in the bank.
But not all lenders impose this kind of requirement. Some only require sufficient funds for closing costs and down payments. Others want to see one to six months worth of payments in the bank. This item seems to be on an upswing lately. We are hearing about well qualified borrowers being denied a mortgage for this one factor alone. It even happened to one of our writers.
Employment History: Did you just land a new job? Congratulations! Normally, this is cause for celebration. But when it comes to mortgage loans, it might actually work against you. Most lenders today want to see a history of stable employment, for at least two years. Of course, there are exceptions to every rule. But this is the standard rule.
You must also be able to document your employment and income. In the past, during the housing boom, a borrower could simply state his or her income. Those were the days of stated-income loans and low-documentation mortgage approval. Those days are gone. You’ll have to provide documentation that proves your income, employment, debts and assets.