Editor’s note: This is the second article in a two-part series. In part one, we explained how the overall rate of mortgage loan rejection has declined steadily over the last few years. This report focuses on the leading cause of application denial.
According to a recent housing report, the “debt-to-income ratio” was the most common cause of mortgage rejection in the United States during 2017. It led to more home loan denials than any other single factor. That’s partly because Americans are carrying more debt these days, on average.
Debt-to-Income: Leading Cause of Mortgage Rejection
In October 2018, the real estate analytics company CoreLogic put out a detailed report relating to mortgage denial in the U.S. The good news was that the rate of loan denials dropped steadily from 2010 to 2017. This means that a higher percentage of borrowers have been reaching the “finish line” and successfully closing on their loans, compared to previous years.
This report also listed the most common reasons for mortgage loan rejection. Excessive debt topped the list.
This kind of data is publicly available, thanks to the Home Mortgage Disclosure Act (HMDA). This federal law requires lenders to report a variety of details about the individual loans they make. The information goes into a database, where it can be mined for insight. Among other things, the HMDA asks lenders to provide the reason for denial, in cases where they turn down or reject a mortgage loan application.
CoreLogic analyzed HMDA data to produce its recent report. To quote that report:
“According to the 2017 HMDA data, 30.3% of denied applications attributed ‘debt-to-income ratio’ as the primary reason for mortgage loan denial, up from 28.8% in 2016 and 28.2% in 2015. In fact, since 2015 it has become the number one reason that lenders have turned down purchase-mortgage applications.”
In earlier years, a poor credit history was the number-one reason for mortgage rejections nationwide. But the debt-to-income ratio has surpassed credit history over the past few years, making it the top reason why loan applications get turned down.
Definition: The debt-to-income ratio, or DTI, is a numerical comparison between (A) the borrower’s gross monthly income and (B) the amount of money he or she spends on recurring monthly debts. The combined or “back-end” DTI, which lenders are most concerned with, includes all types of recurring debt such as auto loans, credit cards, and the mortgage loan itself.
While mortgage lenders consider a variety of factors when reviewing loan applications. They examine bank balances, employment history, credit scores and more. They also use the DTI to ensure that a person isn’t taking on too much debt relative to their income. And based on this report, it’s the debt-to-income comparison that leads to the most mortgage rejections.
Related: How much debt is too much?
DTI Standards Are More Relaxed Today, as of 2018
Here’s some good news to counter the doom and gloom above. The standards for debt-to-income ratios have actually eased over the last couple of years. These days, mortgage lenders are allowing borrowers to have a higher level of debt.
This is largely due to policy changes made by Freddie Mac and Fannie Mae. Those are the two “government-sponsored enterprises,” or GSEs, that buy loans from lenders and sell them to investors. Fannie and Freddie are now regulated by the government, and they have strict criteria for the kinds of loans they can purchase. One of those criteria has to do with the debt-to-income ratio.
Over the last couple of years, Fannie and Freddie have increased their maximum allowable DTI for the loans they purchase. The limit rose from 45% to 50%, allowing borrowers to qualify with higher debt levels than before.
Meanwhile, however, the average level of household debt in America continues to rise. According to an August 2018 Reuters report:
“Americans’ borrowing reached $13.29 trillion in the second quarter, up $454 billion from a year ago, marking a 16th consecutive quarter of increases, a New York Federal Reserve report released on Tuesday showed.”
So while the DTI limits are higher now than in previous years, so too is the average level of debt among borrowers. This is likely the leading cause in the rise of DTI-related mortgage loan rejections.