Here are several issues that can affect the likelihood of getting your mortgage approved and strategies to manage them
Since home loans often take many years to repay, mortgage lenders follow a stringent screening process before granting their approval. This includes proving that you are a reliable borrower through your credit history and earning sufficient income to make payments on time.
Whether you are a first-time home buyer or have been rejected for a mortgage in the past, there are several red flags that could impact your application. Below are seven of the most common issues that could cause problems with your mortgage application and tips to improve your chances of getting approved.
1. Having a poor credit score or no credit history at all
Applying for a loan with little or no credit history is like applying for a job without a resume. Mortgage lenders require records that show you can reliably make repayments and handle your debt.
Moreover, having a good credit score can increase your chances of obtaining both approval and favorable interest rates. According to the Home Mortgage Disclosure Act (HDMA) data, around 22% of home loan applications get denied due to poor credit history.
You should aim for a FICO credit score of 700 to get the best rates. If that’s not realistic, try to get as close as you can by paying your bills on time and maintaining a low credit utilization ratio.
You can also check your credit score by getting a copy of your credit report from the three major credit bureaus: TransUnion, Equifax, and Experian. Under federal law, you can request one for free every 12 months.
2. High debt-to-income ratio (DTI)
Your debt-to-income ratio (DTI) refers to the percentage of your pre-tax monthly income that goes to servicing your debts, such as credit cards, auto loans, mortgages, and student loans.
A DTI ratio of 20% is considered low and a good sign for lenders that you can pay responsibly. However, DTIs above 43% may prompt them to ask for more proof that you can pay off the loan.
In fact, HMDA data indicates that almost 80% of applications with DTIs over 60% get denied.
As such, you should keep your overall debt low and postpone large purchases to use less credit. Use a loan calculator at least once a month to check your progress.
It also helps to learn about various mortgage types and policies from different lenders. You might find a loan option that suits your financial situation better.
3. Low down payment or high loan-to-value ratio (LTV)
The loan-to-value (LTV) ratio is the ratio between the loan amount and the value of the property. Lenders like to see low LTVs to know that their investment is protected in case of default.
Saving up for a bigger down payment can increase your chances of approval, though it’s still possible to secure a mortgage even if your LTV is higher than 80%.
For such cases, lending institutions will require you to get third-party mortgage insurance to protect their interests. Just note that you will pay an insurance fee on top of your closing costs and monthly dues.
4. New loans and last-minute purchases
Another common pitfall that you should avoid is making big purchases right after filing your mortgage application.
Let’s say your current DTI ratio is 42%, which is just under the 43% limit of most lenders. You will likely exceed that threshold if you buy a new car with a monthly auto-loan amortization of $500 – and that will probably lead to your mortgage application being rejected.
The bottom line is you should postpone large purchases and avoid making other loans before your application closes. Talk to a mortgage professional before you do anything that breaks your normal spending habits.
5. Major changes in your lifestyle
Lenders may also take into account major life events, like starting a family or going on maternity leave at the time of your loan application.
They may become wary of your financial capacity, so they’ll probably require additional proof that you can make monthly payments without hiccups.
Similarly, if you’re going through a divorce, you have to reevaluate your financial capacity – especially if you’re buying a new property alone. It can also boost your chances to properly handle joint loans that you previously made with your ex-spouse.
6. Large bank deposits
Having a large amount of money deposited into your bank account is usually a reason to celebrate – but not when you have a pending loan application.
A “large” deposit means any out-of-the-norm amount that gets credited to your savings or checking accounts. Your loan underwriter may flag unusual deposits to confirm that you didn’t take out a new loan and the money came from acceptable sources.
For instance, the deposit should not come from a party that may benefit from the transaction like a real estate agent or the home seller.
You need to provide proper documentation and receipts in case you got the money from selling your car or receiving payment for a personal loan.
You must also declare all your income streams when applying for a loan, so unusual deposits may indicate that you have undocumented sources or side gigs.
Ultimately, it’s fine as long as you can prove the legitimacy of the deposit. The lender will not take an IRS tax refund or regular salaries from your employer against your mortgage application.
7. Incomplete documents and errors on your application
Your prospective lender wants to know the full story of your finances, so they need a copy of your tax returns for the past year or two. They may also ask for your recent pay stubs and W-2s.
You must supply all documentary requirements like photo IDs, credit reports, renting history, and bank statements. Most lenders will also request a written statement from you to explain blemishes in your credit history.
Finally, review and double-check your mortgage application forms and requirements before submitting them. Spelling mistakes, erroneous information, and incomplete attachments can slow down the process or even result in rejection.