It’s one thing to decide that you’re ready for homeownership, and another entirely when it comes to getting a loan. What the lender says is all that matters – it will make or break your chance at attaining the American Dream.
There are many reasons why applicants may be turned down for a mortgage. Some can be remedied immediately while others may take time. Let’s take a look at some of the most common reasons why folks are denied a home loan.
1. Your Debt-to-Income Ratio Is Too High
The number one reason that people are turned down for a mortgage is debt. Even if you have enough money to make the loan payments, if you are deeply in debt, you represent a poor risk and you most likely won’t get a mortgage – from anyone.
Lenders look at your debt-to-income ratio (DTI) when determining what kind of risk you represent. They will calculate two ratios, the “front end” and the “back end.”
The front-end ratio is based on your gross income and factors in your new mortgage payment (including taxes, interest and insurance) if you were to get the loan. Lenders consider a front-end DTI of 28 percent or less of your gross monthly income an acceptable risk.
The back-end ratio is comprised of your income and all of your monthly debt payments, such as rent, loan repayment, credit card payments and others. Although common opinion says this ratio is safe at 43 percent, Ellie Mae claims that the average back-end ratio for an approved applicant is 34 percent. The Federal Housing Administration’s average is 41 percent. “The average for denied applications was 47%,” reported Kenneth R. Harney in the Los Angeles Times.
Don’t give up the dream if you are denied because of a high debt-to-income ratio. Either work on bringing down your debt, or raise your income, and before you know it you’ll have a loan approval letter in your hands.
2. Your Income Isn’t High Enough
If your income is too low to afford the monthly payments on the home, the lender won’t lend to you. Makes sense, right? Well, yes, when we’re talking about conventional lenders.
With low income, or even very low income, you can still get a home loan through the U.S. Department of Agriculture (USDA). You’ll need to make compromises, such as living in a rural area and doing without the bells and whistles (such as a pool), but the loan allows you to get your foot in the door of homeownership.
Speak with your real estate agent about loan options for lower income Americans.
3. Your Credit Score Is Too Low
Many would-be homeowners automatically think that their credit rating is the end-all, be-all when it comes to being granted a loan. While it is important, even the best credit score can’t erase other problems.
Lenders use a formula that is based on a score compiled by the Fair Isaac Corporation, known as your FICO score. FICO uses information from your credit reports, typically those compiled by the “big three” credit rating agencies: TransUnion, Equifax and Experian. This information is combined in a complicated algorithm to produce your three-number FICO score.
Scores range from 300 to 850, and the higher the number, the better the score. The average FICO score on a closed loan is currently 740. This doesn’t mean you can’t get a loan if your score is lower, it just means you’ll have to be more diligent in your search for one.
Once you’re under contract for a home, it’s important not to make any financial changes that might impact your credit reports. This means avoiding any large purchases and not switching financial institutions. Don’t switch jobs, either. Ensure that your finances and work life remain the same during the period from opening escrow to closing.
4. The Home’s Appraised Value Is Too Low
After you submit an offer to purchase a home, your lender will send out an appraiser to determine the home’s value. If the appraised value turns out to be less than what you offered on the home, your loan won’t go through.
A low appraisal, however, doesn’t spell instant doom for your dreams of homeownership. There are several ways to work around the situation:
- Ask the seller to lower the price.
- Come up with more cash down to reduce the amount you need to borrow.
- Ask the seller to meet you halfway. You pay half of the amount over the appraised value and the seller pays the other half.
- Challenge the appraisal.
While there are other reasons you may be turned down for a home loan, these are some of the most common. Thankfully, most of them can be remedied and you can be on your way to homeownership.