Nothing can be more disheartening during the homebuying process than being denied a mortgage. Fortunately, receiving a rejection doesn’t mean a buyer has to give up on the dream of homeownership. With some education and a game plan, prospective homeowners can move forward after a mortgage denial.
State of the industry
According to a recent analysis, almost one in 10 buyers receives a mortgage denial, which is the lowest denial rate since 2004.
The most common reasons for mortgage denial involve the amount of debt a buyer has and their credit history. But those aren’t the only factors that lead to rejection. Collateral is the third highest reason buyers aren’t approved, meaning the home does not meet the lender's appraisal standards.
With multiple factors at play, a mortgage denial is always a possibility. Depending on the reason for the rejection, moving past the denial could mean addressing a buyer’s debt, increasing their down payment or perhaps finding a new property.
How to walk your client through a denial
There are multiple ways to address a mortgage denial. Use these tips to make the rejection less stressful for your client and guide them through their next steps.
Find out why the mortgage was denied: The most important step is to find out the specific reason the loan was rejected. With that information, you and your client will know how to proceed. When a lender denies a prospective buyer a loan, they must notify the buyer in writing.
If the reason for the rejection is related to information in the buyer’s credit history, the letter will also include the name of the credit bureau that furnished the information. Sometimes, a denial letter will provide a vague reason such as, “You didn’t meet our minimum standards.” In that case, your client will need to dig a little deeper and go directly to their bank or lender to inquire why their application was denied.
Knowing the exact reason for the denial will also ensure that the lender is not engaging in unlawful mortgage discrimination.
Review credit reports and dispute incorrect information: If a buyer’s application is denied due to their credit history, they are entitled to a free copy of their report within 60 days from the credit bureau named in the denial letter. Your client should review the information and dispute any inaccurate items. Once the information is corrected, the buyer should make sure a summary of the correction is included in their credit report.
Pay down debt: The number one reason for rejection is a high debt-to-income (DTI) ratio, which refers to the percentage of a borrower's gross monthly income that goes toward debt payments. For example, if a borrower with a gross monthly income of $6,000 has monthly debt payments that total $2,500, their DTI ratio is 42%. Lenders typically want a DTI ratio of 43% or less, including the mortgage payment. A buyer can lower their DTI ratio by eliminating some debts.
Consolidate debt: If a consumer does not have available funds to pay down debt, another way to reduce their DTI ratio is to consolidate debt with a personal loan or a zero- or low-interest credit card. Of course, this strategy only works if the new loan or credit card is at a lower interest rate than the existing debt. If you have a credit score around 700, you’ll have better luck getting a loan with better terms. The caveat with this approach is that taking out new credit during the mortgage process could ding a borrower's credit and hurt their chances of being approved the second time around.
Increase income: Another way a consumer can lower their DTI ratio is by increasing their income. If your client can take on another job or increase their salary at their current job, this could also improve their chances of approval.
Increase the down payment: A larger down payment may help the chances of approval if the reason for denial was a low credit score. Increasing the down payment can also fill in the gap between what a lender will approve and the price of the home.
Pursue a different property: If the current property did not appraise high enough or the inspection or appraisal revealed some issues, then the consumer should move on to a less expensive property or one with fewer potential problems.
Consider another lender: Depending on the reason for the denial, a buyer may be successful in securing a loan from a bank or lender with different lending requirements.
Seek credit counseling: Pursuing credit counseling with an HUD-approved counselor could help your client get a handle on their overall financial situation.
Delay the purchase: In some cases, time can make the difference. Waiting may provide a buyer time to increase their savings, improve job history or put some distance in between negative items on their credit report and their next attempt at applying for a mortgage.
Buyers who receive a mortgage denial don’t have to give up on owning a home. With some education beforehand and an understanding of what to do in the event of a rejection, consumers can face the denial and move forward with a plan.