You’ve finally found the house of your dreams and applied for a mortgage, only to find out that your application was denied. Your hopes are dashed. Denial of a mortgage application can be devastating for a variety of reasons, such as a poor credit score, no credit history, too much debt, or insufficient down payment.
Understanding how the mortgage borrowing process works as well as the role your credit and finances play will help you understand why your mortgage application was rejected. Because mortgages are such large loans, lenders typically require borrowers to meet a long list of requirements before their applications are approved. One of these requirements may be enough to disqualify someone from the program. Before you apply for a new loan, here are some things you should know.
If you’re applying for a mortgage, there are several common reasons why it might be rejected.
• Low credit score: The minimum credit score required to get a mortgage varies from lender to lender and type of mortgage. Typically, a FICO® score of 620 is required for a conventional mortgage or VA loan; 640 is required for a USDA loan. Even if your credit score is as low as 500, you may be eligible for an FHA loan, but you will be required to put down a larger amount of money. For more information on each loan type, see the table below.)
• No credit history: You may have a “thin” credit file if you don’t have any credit cards or loans to your name. This indicates that your credit history is nonexistent or extremely limited. Lenders will have a hard time approving your mortgage application if you don’t have a credit history that they can use to determine your creditworthiness.
• High debt-to-income (DTI) ratio: Lenders look at how much of your monthly income goes toward paying off debts to determine whether or not you will be able to repay the loan. Applying for an FHA loan may make it more difficult if your housing payment is 31% or more of your gross monthly income.
• Small down payment: Your ability to repay a mortgage is increased because you demonstrate to lenders that you have invested in the purchase of your home. The more money you can put down, the better your chances of getting a mortgage.
• Missing application information: Your mortgage application may be rejected even if you have excellent credit and a steady income if you omit or forget to include essential information. Make sure your application is complete before submitting it to avoid disappointment.
• Recent job change: Recent job changes may raise concerns about your ability to keep a steady job with a mortgage lender. To increase your chances of getting hired, try sticking with one employer for at least two years.
Lenders look at several different things when determining whether or not you are creditworthy when evaluating your mortgage application.
• Payment history: Your credit score will rise if you have a long history of making on-time payments to your creditors.
• Credit utilization ratio: A high credit utilization ratio indicates that you are using a significant portion of your available credit. Credit scores can suffer if your debt-to-income ratio is 30 percent or more, which indicates to lenders that you are unable to fully repay your current debt obligations. The better your grades, the lower this ratio should be.
• Recent credit applications: If you’ve applied for several different types of credit in the last few months, lenders may interpret this as a sign that you’re in financial trouble. Hard inquiries on your credit report will remain on your credit report for two years after you apply for credit.
• Major derogatories: Credit bureaus look for red flags such as bankruptcies and collections as well as charge-offs and accounts settled for less than the amount owed when evaluating your creditworthiness.
• Authorized-user accounts: To build your credit, you can become an authorized user on a card, but lenders will not consider this an indication of your credit management skills. When the lender determines your DTI ratio, the account may work against you.
• Dispute statements or pending disputes: Your credit history will be clearer once any disputes on a credit report have been resolved before lenders will give you a mortgage.
In addition, keep in mind that there are a variety of mortgages available, each with its own set of qualifying requirements. A closer look at this.
• Conventional mortgage loan: No government programs or agencies are backing conventional mortgage loans. Bank, credit union, and mortgage lender loans are included in this category.
• FHA loans: With FHA loans, you don’t have to worry about your credit being checked because they’re guaranteed by the Federal Housing Administration (FHA). To buy a home, you only need to put down 3.5% of the purchase price. Private mortgage insurance will be required for the entire term of the loan.
• VA loans: Because these loans are insured by the Department of Veterans Affairs (VA), you don’t have to save up a down payment for a home purchase. Building a new home, remodeling an existing one, or expanding an existing one are all viable options for those who qualify for a VA loan.
• USDA loans: Rural and suburban homebuyers with low to moderate incomes who meet certain requirements may be eligible for these loans. Loans from the USDA do not require a down payment and are backed by the federal government.
• Fixed-rate mortgage: These loans have a fixed interest rate for the entire term of the loan, so you don’t have to worry about your monthly payments rising over time. For the most part, fixed-rate mortgages have terms of 15,20 or 30 years.
• Adjustable-rate mortgage: For a short time, the interest rate on these mortgages is fixed, but after that, it is subject to annual adjustments based on changes in the market. Fixed-rate mortgages typically have lower interest rates than adjustable-rate mortgages, but your monthly payments may rise significantly over time.
• Conforming loan: Federal Housing Finance Agency (FHFA) and Fannie Mae and Freddie Mac, government-sponsored enterprises that buy and administer most US home loans, define a conforming loan as one that falls within the FHFA’s and Fannie Mae’s parameters. Conforming loan limits for 2020 have been set by the Federal Housing Finance Agency at $510,400 or less in 48 states and $765,600 or less in Alaska, Hawaii, and some high-cost areas.
• Non-conforming loan: AA jumbo loan is a mortgage that exceeds the conforming loan limit. For a jumbo loan, you’ll need a higher credit score, a larger down payment, and more assets than you would for a conforming loan to get approved. A higher percentage of the loan amount must be paid in fees and interest over the life of the loan.
The lender will send you a declination letter (also known as an adverse action letter) if your mortgage application is denied. If your application is rejected, you have the right to a free copy of your credit report. The letter of declination should include information on how to obtain a copy of the credit report that was used in making the decision.
Lenders are legally required to explain why they rejected your application. To find out why your application was denied, speak with the lending institution directly. Loans are often denied because of a lack of income, bad credit, or a high debt-to-earnings ratio. You’ll be able to figure out what went wrong with your credit if you look at your report.
If you wait until you receive a declination letter to learn that your credit is a problem, it may be too late. To ensure that you will be approved for a mortgage, it is important to obtain a copy of your free credit report and free credit score.
Make sure your credit report is error-free by requesting a correction if necessary. Before applying for a mortgage, work on raising your credit score. Increasing your chances of obtaining a mortgage and successfully repaying it can be achieved by reducing your debt, demonstrating good credit habits, and decreasing your credit utilization.
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Bel Air, MD
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