Many readers come across this blog when they’ve just been denied for a mortgage and they need help figuring out what to do next.
There is not much worse than being ready to buy a home only to be denied financing by the lender.
First of all, don’t feel bad. Mortgage lenders turn down 30% of people who apply for a home loan.
Most of the time borrowers can clean up their past credit messes and resubmit the mortgage application rather quickly.
The key is getting your credit history fixed as quickly as possible.
5 Steps To Take If Your Mortgage Was Denied
Here are the five things you need to do when you’re denied a mortgage loan:
- Find out why you were denied a mortgage loan
- Calculate Your Debt-to-Income Ratio
- Determine if You Should You Apply for an FHA Loan
- Remove Negative Items From Your Credit Report
- Seek Help from a Credit Repair Professional
1. Find out exactly why you were denied
By law, you have the right to know why the mortgage lender denied your home loan application. Mortgage lenders must provide you with a letter stating the reason you were denied.
If the loan denial letter doesn’t go into much detail, ask your loan officer to provide more specific details.
Common reasons for mortgage application denials normally stem from two sources:
- problems with the home
- problems with the borrower’s creditworthiness.
Problems with the home could include a low appraisal. A bank won’t lend more money than the home’s appraised value.
In this case you’d need to get the home’s seller to come down on price. Or you’d have to stop trying to finance closing costs into the loan.
Some loan types include home safety requirements. Loan denials can happen if the home has lead paint or doesn’t meet another safety guideline.
Problems with the borrower’s credit are more complex. Today’s automation within the mortgage underwriting process doesn’t leave much room for human interpretation. If your credit score comes in too low you could get your mortgage loan denied right away.
Often, credit reporting errors cause sudden, and unexpected credit score decreases. We’ll get more into this problem below. For now, just find out why your home loan was denied.
2. Make sure your debt-to-income ratio is reasonable
If your mortgage is denied because you have too much debt compared to your monthly income, you’ll need to make some personal finance decisions before reapplying for a home loan.
Lenders track your debt-to-income ratio (dti) because they want to know whether you’ll be able to afford the loan’s monthly payment. If you can’t afford the monthly payment, lenders can’t afford to extend you new credit.
This is why lenders ask new homeowners about their employment history and want copies of pay stubs or bank statements.
When a mortgage lender knows you’re strapped with car loans, personal loans, credit cards, and student loans, underwriters may decide you have too much monthly debt to afford the home loan’s monthly payments.
This can happen even if you already own the home and are refinancing into a lower rate or shorter loan term.
To fix this problem, you’d need to pay off some of your high debt or get a new job that brings in more monthly income to lower your debt-to-income ratio.
You could also put down a larger down payment which lowers your mortgage payment and increases your chances of mortgage approval. (Of course, if you had the money to make a larger down payment, you might as well pay off debt instead.)
One more option: You could find a home with a lower purchase price.
3. Determine if you should apply for an FHA loan
Conventional borrowers who get loan denials should consider alternative types of home loans. You may want to consider an FHA loan, for example. These mortgage loans are often available to people with FICO credit scores as low as 580.
FHA loans are insured by the Federal Housing Administration, so you’ll have to pay mortgage insurance throughout the life of the loan.
Mortgage rates for FHA loans often come in lower than conventional loans because lenders have guarantees from the FHA.
You might want to consider applying for an FHA loan if your credit score is lower than 650 or you have a short sale, foreclosure, or bankruptcy in your credit history.
However, you should also know that significant credit blemishes require waiting periods for FHA or conventional borrowing:
- Foreclosure: Conventional loan requires a 7-year waiting period. An FHA or VA loan requires a 3-year waiting period.
- Short Sale: Conventional loan requires a 4 year waiting period. An FHA requires a 3-year waiting period. A VA loan (available only to veterans and active-duty military personnel) requires a 1-day waiting period.
- Chapter 7 Bankruptcy: Conventional loan requires a 4-year waiting period. An FHA or VA loan requires a 2-year waiting period.
- Chapter 13 Bankruptcy: Conventional loan requires a 2 year waiting period. An FHA loan requires a 1-year waiting period.
4. Remove negative items on your credit report
Many homebuyers who get a mortgage denial had no clue the credit bureaus report negative items and low credit scores on their credit reports. They never imagined failing to meet a bank’s minimum credit score.
If you had no idea about your low credit score, it’s possible mistakes and errors by the credit bureaus — Experian, Equifax, and TransUnion — may be a factor.
If your loan denial letter cites your credit score, you’ll want to get copies of your credit reports right away. You can see your reports at annualcreditreport.com.
This sounds like a big hassle, and it will take some time. But there’s good news: If credit reporting mistakes caused your mortgage denial, you can get your home purchase or refinance back on track by fixing credit reporting errors.
I have already written a lot about credit repair, so I’m going to link to several articles:
- Remove Late Payments From Your Credit Report
- Remove Collections From Your Credit Report
- Remove a Charge Off From Your Credit Report
- Remove Tax Liens From Your Credit Report
Credit report errors hurt you in several ways. They can inflate your credit utilization ratio along with showing inaccurate payment history — both of which impact your FICO a lot.
5. Have a professional clean up your credit
You could also hire a professional to get your credit history back into shape before your next mortgage application.
I suggest you check out Lexington Law Credit Repair.
With your credit back in shape you could get pre-approvals from several different lenders so you can find the best interest rates in the real estate lending market.
Lexington Law will advocate on your behalf with the credit bureaus in exchange for a monthly fee.
Check out their website.
Many homebuyers find Lex Law’s fees to be significantly less than the savings a lower interest rate can create over the life of a new mortgage loan or a home equity line of credit.
Mortgage Loan Denied in Underwriting: What Happened?
Getting a mortgage pre-approval means you should be able to close your home loan based on the information you provided your lender.
However, a pre-approval is not a guarantee you’ll get your mortgage approval without incident or at all.
Mortgage applications could still be denied in underwriting. Underwriters will pore over your credit history, your monthly income, tax records, and bank statements.
If underwriters uncover problems or fail to find the right documentation, they can deny your mortgage during the underwriting process.
If this happens they have to let you know what prompted the denial. You’ll have a chance to fix the problems and get your mortgage application process back on track.
Sometimes, even if you get a mortgage denial in underwriting, you can still get your home loan closed on time or with a minimal delay.
Mortgage Loan Denied at Closing: What Happened?
When your mortgage loan is denied in underwriting, you still have a chance to stay on schedule. Or you may have to delay closing for a week or two.
But what happens if you get your home loan denied on closing day? Talk about disappointment.
Mortgages denied at closing often result from sudden changes in your credit history or personal finances — or changes to the property itself.
Problems with the home include title search issues. If your closing attorney can’t find documentation that the seller rightfully owns the home, the sale won’t go through.
The same could happen if the current owner owed old property taxes and the county put a lien on the property.
Your personal finance changes could include a new job, a loss of a job, a sudden credit score drop, failure to sell another property you already own, or problems resulting from the source of your down payment.
If you’re using gifted money for the down payment, you’ll need a letter from the donor saying he or she will not expect repayment or a lien on the real estate you’re buying.
Be sure you don’t apply for new credit, including credit cards, during your mortgage application process. If you use a gift for your down payment, try to leave the money in your bank account for at least three months before applying for your mortgage loan.
Pre-Mortgage Application Credit Repair
Your credit score will be a huge part of your mortgage application process — whether you get a conventional loan or a government-insured loan such as an FHA, USDA, or VA loan.
So it makes sense to repair or tune-up your credit before applying for a new home loan or refinance.
Here’s where to focus:
- Payment History: This is the biggest component of your FICO score. Make on-time payments every month on every account if possible.
- Credit Utilization: Using less of your available credit will help your FICO score. Try to pay your credit card balances down to 30% of their credit limits. Also, don’t close accounts even if you’ve paid them off completely since doing so could lower your available credit.
- Other Factors: Limiting your applications for new credit, keeping a good mix of different types of open accounts, and keeping your accounts open so they’ll age can boost your credit history.