Why Your Mortgage Could Get Declined

Congrats! You've found a home that fits all your criteria and you've applied for a mortgage—only to have your hopes quashed when you learn your application has been denied. Such news can feel defeating, but it’s not a reason to lose hope, especially as a first-time homebuyer. 

A denial can happen for various reasons, including a poor credit score, no credit history, too much debt, or insufficient down payment.

To remedy this situation, you'll want to revisit how the mortgage borrowing process works and get a handle on the role your credit and finances play. Mortgages are no small commitment, so lenders tend to have a laundry list of conditions a borrower is expected to meet before they're approved. Failing to meet just one of these requirements can be grounds for denial. Here's what you should know before you give it another go:

Why are Mortgage Loans Denied?

While each situation is different, there are several common reasons why loans are denied:

Low credit score: The minimum credit score needed to secure a mortgage varies depending on the lender and mortgage product. For a conventional mortgage or VA loan, the minimum FICO® Score☉ needed is typically around 620. For a USDA loan, expect 640. You can get an FHA loan with a credit score as low as 500, but you will have to make a bigger down payment than if you had a higher score.

No credit history: If you don't use credit cards or don’t have a loan history, you may have what's called a "thin" credit file. In other words, lenders consider this a very minimal credit history—or none at all. Without such a track record to size you up, lenders will find it difficult to approve you for a mortgage unless they can find other reasons to make the case that you’re a responsible borrower.

High debt-to-income (DTI) ratio: As another means to vet you as a potential borrower, lenders will review the percentage of your monthly income dedicated to monthly debts. It may be harder to qualify for a loan if your housing payment is 28% or more of your gross monthly income (31% or more if you're applying for an FHA loan).

Small down payment: Allocating money for your home purchase shows lenders you’re serious about the endeavor, making you more likely to repay the mortgage. The bigger the down payment you can make, the better chance you have of getting the green light.

Missing application information: Mistakes happen but know that you may be denied if you omit or forget to include certain details. That’s why it’s a good idea to review your application carefully to make sure it's complete before submitting it. You might consider asking a friend or family member to give it a once over, as the stakes are high.

Recent job change: Stability inspires confidence; recent job changes may hurt your cause. However, having the same job for at least two years may help your chances of approval.

New debts after you apply: This is one of the most common reasons you could be denied a mortgage even after being initially approved.

You might be confused by this scenario. That’s why it helps to understand the steps involved. When you get a mortgage, your lender will typically pull your credit report and score at least twice — once when you initially apply for the loan, and again shortly before closing. Any major changes can create a problem, especially if the recheck shows that you've opened new credit cards, charged large purchases, or done anything else that could jeopardize your status as a borrower. So that’s why the experts tell you to refrain from making any major purchases until after closing.

Issues with the home itself: You might be surprised to learn that this can cause an issue. Lenders want to make sure the home is actually worth what you're paying for it so that in the event of a foreclosure, the lender has an asset it can easily sell to recover losses. This means if a home doesn't appraise for enough, you might have a problem on your hands. You may need to put more money down or try to negotiate a lower selling price that's in line with the appraisal.

What to Do If Your Mortgage Application Is Rejected

If your application is rejected it helps to know what to expect. You'll receive a declination letter (also called an adverse action letter) from the lender. By law, you are entitled to a copy of your free credit report if your application is denied. Such a document should provide instructions for getting a copy of your credit report from the credit reporting agency that was used to make the determination.

You should also know that lenders are required to tell you why your application was denied. If the declination letter doesn't specify a reason, you have the right to ask. Most often, loans are declined because of poor credit, insufficient income, or an excessive debt-to-income ratio. Reviewing your credit report can help provide some clarity in this case.

Next Steps

When it comes to qualifying for a mortgage, you can’t start preparing too early. Don't wait until after you receive bad news to learn that there's a problem with your credit. Before you begin the application process, obtain your free credit report and free credit score to see if there are any wrinkles that could cause issues down the road.

If there are mistakes on your credit report, you have the right as a consumer to have them corrected. If your credit score is too low, work on bringing it up by following tried-and-true tips. Paying down debt, maintaining good credit habits, and reducing your credit utilization can all work in your favor.

The bottom line here is that you might experience a snafu in the application process, but it doesn’t necessarily mean a dead end. Some of these issues can be addressed relatively easily, while others might require more work on your end.

For more on the fundamentals of first-time home buying, including a link to get preapproved, visit ruoff.com/first-time.