Buying your own home is probably one of your topmost personal goals, and if you haven’t saved enough to achieve it yet, then you’re very likely considering getting a home loan. But before you start falling in love with a home you may have found, you need to be sure that you can get preapproved for a mortgage, otherwise, your desire to have a home might be frustrated.
There are a variety of reasons why you might not get pre-approved by a lender for a home loan, and even when you get pre-approved, you might still be denied the loan if major changes occur in your credit history or financial situation.
What Is Mortgage Pre-approval?
A mortgage pre-approval is a document presented by a lender indicating the possibility of you being qualified for a mortgage loan based on the financial record that you have provided them. The document will also reveal the amount of money that you’ll be able to borrow.
Depending on your lender, there is varying documentation that would be required before you will be approved. Some lenders may request your personal details, estimated credit score, and annual earnings, while some others may request a credit check and your total financial documentation.
Being pre-approved for a mortgage loan will help you make the best decisions as regards home-buying. But it is different from the mortgage approval, and not a guarantee that you absolutely get the funds you requested for. However, you’ll have a budget to work with and be able to show sellers your level of credibility in being provided funds.
Why Do Lenders Deny Preapprovals
There are diverse reasons why a loan applicant may not get the requested loan. But the summary is how risky your lender perceives you are. Consumer Financial Protection Bureau’s (CFPB) analysis of 2019 mortgage-application denials revealed high debt-to-income (DTI) ratios as a high cause for mortgage loan denials.
Other top reasons stated for denials were collateral and poor credit history. So, about 8.9% of mortgage applicants were denied in 2019.
While the Home Mortgage Disclosure Act requires lenders to forward reports on the denials of mortgage loan applications, however, denied preapprovals weren’t reported.
If you understand why lenders reject mortgage applications, you’ll be able to prepare better before applying.
Factors That May Lead To Mortgage Application Denial
1. Your Credit History
If your credit history isn’t good enough, you might get rejected for a mortgage loan pre-approval. Lenders consider your repayment habits when considering you for a loan. They also look at the outstanding loans you have, how much of your credit limit you are using, and the number of credit cards you have.
CFPB revealed that 19% of mortgage loan applications were denied in 2019 because of poor credit history. Late payments, a high number of debts, and accounts in the collection are other factors that are considered.
2. High Debt-To-Income Ratio
You are not going to get preapproved for a mortgage loan if your debt-to-income ratio is high. Your debt-to-income ratio discloses how much goes into repayment of debts in your monthly income. These include your credit card bills, student loan payments, and potential mortgage payment. The Consumer Financial Protection Bureau’s (CFPB) analysis revealed that about 30% of rejected applications were connected to DTI. Potential lenders want to see a DTI of 43% and below.
3. Low Value of Home/ Poor Collateral
You will be providing your home as collateral for your mortgage loan, so, if you default on your loan repayment, your lenders will foreclose on the house and sell it to regain their money. In certain cases when the house isn’t valuable enough for the proposed loan, you might not get preapproved for a mortgage. The CFPB says about 14% of purchase application denials in 2019 were as a result of insufficient collateral.
Since the heat of the coronavirus pandemic, lenders have had to stiffen their lending standards. Some have lowered their debt-to-income ratio while others have increased their credit score and down payment requirements. These developments make it harder for mortgage pre-approval in the current environment.
4. Change of Employment
One thing you might not be aware of is that lenders do not only consider how much income you earn, but how you have been able to hold a steady job in the past. There are some loans that will not be provided if you haven’t met a specified period of consistent employment – typically two years. But if you had just kick-started a new career in the middle of your home search, it means that you’ll not meet the requirement.
What Should I Do If My Application Gets Rejected?
If you get denied, you should consider asking your potential lender questions. The answers you receive can help you understand what went wrong with your application and also be able to make necessary corrections. Some measures that can help you get back up include:
Improving your credit score
Settle your accounts in collections, pay down balances on your credit cards, notify credit bureaus of errors on your credit report, and get caught up on overdue payments. Doing this will effect positively on your credit score.
Clear your debts
Target lowering your DTI below 43%. The more you are able to reduce your loans the more reduced your debt-to-income ratio will be.
Get an extra source of income
You can also reduce your DTI by increasing your monthly earnings. Find a suitable side gig for more cash, but be aware that potential lenders typically take your past two years of income into account when evaluating your mortgage loan repayment ability.
You need a consistent stream of income that can help you stay steady with paying your bills on time and also improve your chances of getting approved.
Apply with multiple lenders
The requirements for getting qualified for mortgage loans vary with different lenders, especially during the pandemic, so, you’ll likely get better options for approval when you shop around with other lenders.
Tips To Ensure A Mortgage Approval
To ensure a mortgage approval, keep your financial situation steady or improved than how it was before your mortgage pre-approval.
- Do not make huge deposits. This can cause lenders to become suspicious of your transactions, especially if there is no evidence as to its source.
- Do not accumulate more debt. You might want to book a vacation or want to acquire some assets for your new home. Wait till after closing before taking this step.
- Do not withdraw a huge cash amount. While you should refrain from making huge deposits, be also careful of withdrawing huge cash for no reason.
- Add to your savings. It is possible that you have been saving for a down payment before you got pre-approved for a mortgage. Continue to add to your savings on a steady schedule.
Lenders try to make the best decisions as regards loan application approval to help them secure their business. So, if you are not getting preapproved for a mortgage, it doesn’t mean that your home-buying journey has ended. Take further steps to find out the reasons for your application denial and try to correct the issues. While doing this, evaluate your progress with a regular credit report. Also, consider working with a credit or housing counselor. They can be helpful in directing you towards your unique situation and credit.