When you apply for a mortgage loan with a lender, there are a lot of stringent requirements you must meet—and if the bank doesn’t believe you’re financially capable of committing to a mortgage, they most likely won’t approve you.
But you can greatly improve your chances of getting approved for a mortgage by removing the glaring red flags from your application. Let’s take a look at the top reasons for mortgage denials, according to the Home Mortgage Disclosure Act’s (HMDA) most up-to-date data on mortgage applications.
Here are the five biggest reasons mortgages get denied and how to avoid these red flags when applying.
The Main Reasons for Mortgage Rejection
1. Insufficient Debt-to-Income (DTI) Ratio
According to HMDA, 31% of denied applications happen because of a poor debt-to-income ratio. Your debt-to-income ratio is the ratio of your monthly debt payment to your gross monthly income. Having too much debt will hinder your ability to pay monthly mortgage payments, as more of your income has to go toward paying your debts.
Lenders generally want a DTI ratio below 36% to demonstrate you can handle a mortgage on top of your current debts. However, some lenders will go as high as 45% DTI, and FHA loans will consider a DTI of 50% in some cases.
“Insufficient income in relation to the amount of credit requested” is also cited as a reason for denial in the DTI category, so this statistic also considers applicants asking for too much credit based on their income. This means that even if you don’t have any debt, you could get denied for simply not having enough income. Make sure to consult with your loan team and set a realistic expectation for your price range and the required income.
You should also try to reduce your debt as much as possible before you apply. If you have enough cash reserves left over after a good down payment, consider putting that money toward high-interest debt, student loans, or credit cards to reduce your debt. Lowering your debt-to-income ratio will increase your chances of approval, and it could get you better loan rates and terms, too.
2. Poor Credit History
The second highest reason for denial is a poor credit history, which makes up 27.59% of denials.
Lenders use your credit score and history to assess whether or not you’re suited to handle a long-term financial obligation. If you have a poor score or history, it could indicate that you’ve made poor financial decisions in the past, so you’re less likely to get approved.
Lenders determine whether or not you have a poor credit history on the following bases:
|Insufficient number of credit references provided
|Borrower didn’t provide enough credit references for the lender to evaluate creditworthiness
|Unacceptable type of credit references provided; no credit file
|Borrower provided unacceptable credit references or lacks an established credit history
|Limited credit experience
|Borrower has a short credit history, making it challenging for lenders to assess creditworthiness
|Poor credit performance with the lender
|Borrower has a history of late payments or poor credit behavior with the specific lender
|Delinquent past or present credit obligations with others
|Borrower has a history of late payments or delinquencies with other creditors
|Number of recent inquiries on credit bureau report
|High number of recent credit inquiries may raise concerns about financial stability
|Garnishment, attachment, foreclosure, repossession, collection action, or judgment
|Any major financial event like wage garnishment, foreclosure, or judgments impact creditworthiness
|Recent bankruptcy raises concerns about the borrower’s ability to handle new credit responsibly
Submit the proper documentation as requested by your loan officer or underwriter to pull your credit report. If you don’t have a long credit history, there might be other ways to prove your creditworthiness, but you might just have to wait until you build up a good score.
If you have any major credit problems, such as foreclosure, repossessions, or past bankruptcies, you’ll usually need to wait several years for your credit to recover. Foreclosures, for instance, usually mean you can’t get a new mortgage for seven years.
Lastly, it’s very important to not make any major purchases during the application process. This can seriously impact your credit, and while you may have been preapproved for a certain amount before, you won’t necessarily get approved after buying the $35,000 boat of your dreams.
3. Insufficient Collateral
The third main reason for denials is insufficient collateral, which makes up 13.17% of denials. You could get denied if the collateral on the loan is insufficient. In other words, the house you want to buy doesn’t meet the lender’s criteria.
The house is referred to as “collateral” because it’s the bank’s security for the loan. If you fail to make payments, the lender has the right to take possession of and sell the home to recover the outstanding debt.
Because the bank is using your house as collateral on the loan, they have specific requirements for the value and type of home you can buy.
Here are two main aspects to consider:
- Insufficient value: The property’s appraised value might be lower than the amount of the loan requested. Lenders typically have specific loan-to-value (LTV) ratios they are willing to work with. For example, if a lender has an LTV limit of 80%, it means they are willing to lend up to 80% of the property’s appraised value. If the property’s appraised value is lower than expected, it could result in the lender denying the mortgage application or offering a lower loan amount.
- Type of collateral: Some lenders may have restrictions on the type of properties they are willing to finance. For instance, certain properties may be considered high-risk if they have structural damage. Additionally, properties with unique characteristics, such as commercial properties or certain types of land, may pose challenges in terms of financing.
In both cases, the lender is concerned about the risk associated with the collateral. They want to ensure that the property is valuable enough to cover the loan amount in case of default and that it meets their criteria for acceptable types of collateral.
To prevent a mortgage rejection, do everything you can to ensure that the home you’re buying meets the lender’s property requirements. There may be other property requirements depending on the type of loan—government-backed loans such as the VA loan have specific minimum property requirements that all homes must meet to qualify.
If the loan is declined because the appraisal comes in low, there are several things you can do. You can challenge the appraisal if you believe there could be discrepancies in the report. You can also make up the difference in cash and pay the difference between the seller’s price and what the loan covers.
If you want to protect yourself from a low appraisal from the beginning, consider an appraisal contingency. This allows you to negotiate with the seller to try to get them to adjust the price for you, and if that doesn’t work, you can get your earnest money back. This doesn’t help you get the home, but it ensures you don’t walk away from the exchange missing your earnest money.
4. Incomplete Credit Applications
Incomplete credit applications account for 11.42% of mortgage denials. This means that the lender did not receive all the necessary information and documentation required to assess the applicant’s creditworthiness.
Common reasons for a credit application being deemed incomplete may include:
- Missing documentation:
- Borrower may not have submitted all the required documents, such as pay stubs, tax returns, bank statements, or other financial records
- Incomplete personal information:
- Essential personal details, like employment history, contact information, or other relevant details, may be missing or incomplete on the application
- Incomplete credit history:
- Lenders typically rely on credit reports to assess an applicant’s creditworthiness. If there are gaps or incomplete information in the credit history, it can make the assessment difficult
Incomplete credit applications make up over a tenth of mortgage rejections, but they shouldn’t—this can be easily avoided by ensuring that you provide all of the necessary documentation to your loan team.
Make sure all of the documentation you send is accurate and accounted for. Definitely don’t cut any corners—a missing paystub could be the difference between approval and rejection.
5. Unverifiable Information
Unverifiable information makes up 4.29% of mortgage application denials. This may not seem like a lot, but that’s 105,792 denials.
“Unverifiable information” means that the lender couldn’t verify your credit references, employment, proof of income, or residence. If the lender can’t be sure about your credit score, employment history, or income, they won’t be able to accurately determine if you can make your monthly mortgage payments.
Lenders also look at your residential history as a marker of financial responsibility. For example, let’s say you have a history of making rental payments at your current residence for three years. That’s a reliable history of regular monthly payments, and the lender will be more confident that you can commit to a monthly mortgage payment. If the lender can’t verify your residence, that could be a reason for denial.
Make sure all of your credit, employment, income, and residential documentation is up-to-date and in line with what your loan team needs to ensure you don’t get denied for unverified information. Work with your lender closely to learn what documentation is acceptable.
Other Reasons for Mortgage Denials
There are several other reasons that make up the remaining 12.59% of denials. These include insufficient cash, employment history, and mortgage insurance denial.
The fifth highest reason for denial is officially “Other,” which wasn’t included in the top five reasons because it’s a catch-all that captures any unspecified problems invalidating mortgages, such as problems with temporary residences.
To improve your chances of getting a mortgage, make sure you have enough saved up for an adequate downpayment and you have a reliable employment history.
And if you’re denied a mortgage, don’t panic—that doesn’t mean you can’t apply again. In fact, if you tighten up your finances before applying again, you’re likely to get a better rate and reduce the lifetime cost of your loan.