Being turned down for a loan is a major disappointment; approximately 30% of mortgage applications are denied. But the good news is that you can use a mortgage denial as a learning experience and hopefully get approved the next time around. Learning how to meet the underwriting standards so you can be pre-approved for a mortgage can be a process, but it is worth the hassles to become a homeowner in the U.S.
If you want to reduce the chances of being turned down, know the most common reasons it happens:
#1 Bad Credit
Your credit history is a major way for the lender to determine if you are a good risk or not. Lenders will look at your minimum FICO score and also if you have a significant number of late payments in the last few years. A foreclosure or a bankruptcy also can make getting a mortgage difficult, although it is easier to be approved with those on your record than in the past. There are bad credit mortgage loan programs available, but most applicants are turned down from bank and loan companies that do not offer these types of loan programs. Ask lenders and brokers if they offer home loans for bad credit home loans and no money down.
These days, you still may be approved for a mortgage even with a credit score as low as 600. However, you will need to shop lenders to find one that will take a chance on you.
#2 Poor Income Documentation
Mortgage lenders want to see proof that you have the steady income to pay the mortgage as well as your other financial obligations. You may think that you have enough coming in to pay your bills, but the lender will not just take your word for it.
You will need to provide the mortgage lender with two years of tax returns, your W-2s from your job, and a few pay stubs. If you are self-employed, tax returns and a profit and loss statement for the current year are what you need. Most independent contractors and self-employed applicants need to request a stated income loan or a mortgage with less documentation.
#3 Small Down Payment
The mortgage lender looks at your down payment as your skin in the game. That is, you are less likely to default on your mortgage if you have put down a big chunk of your own cash. There are some low down payment loans available but it is easier to get a mortgage if you put down at least 10% of what you are borrowing. There also are FHA loans that require as little as 3.5% down. There are a few 100% programs that do not mandate a deposit. When shopping ask the companies if they offer a zero down home loan.
#4 Property Problems
A mortgage application denial does not always have to do with you. In some cases, the value of the property is not enough to back the mortgage loan you are asking for. It is not unusual for a low appraisal to mess up a mortgage application.
However, if this does happen, you would be advised to shop lenders and you may find someone who will approve the mortgage.
#5 Unstable Work History
A steady history of working is critical when you are applying for your mortgage. Most lenders will require that you have two years of steady income before they will give you a loan. They want to know that you are able to keep a job so that you can pay your mortgage.
You will want to have proof of two years of work history when you apply, including paystubs and W-2s.
#6 Debt to Income Ratio
This is the percentage of your gross income each month that will pay your debts. Lenders usually want to see that you are paying no higher than 38% of your income each month towards debt. Some lenders may allow you to have up to 45% if you have top rate credit or a large down payment.
#7 New Debts Incurred
Another common reason that a loan is denied after a pre-approval is that the applicant takes on more debt. You might be surprised, but there are many stories about people who put in an offer on a house and run off and buy a new car. This can put your debt to income ratio too high and the mortgage can be denied.
It is a good idea to not take on any new debt at least until the deal is closed.
#8 Lending Guidelines Change
There are occasions where a borrower is pre-approved but the mortgage product's guidelines change. For example, if the lender lets you have a 640 credit score but the requirement changes to 675, you could be denied a mortgage.
Other things that can change include debt to income guidelines and the amount of reserves the borrower must have.
If you want to increase the chances that your application is approved, remember these tips:
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