In February 2020, Lending Tree released a study that analyzed the primary reasons why borrowers’ mortgage applications were turned down, using the most recent Home Mortgage Disclosure Act (HMDA) data set from 2018. Because lending institutions are required to report the reason for a mortgage application denial, Lending Tree was able to analyze more than 10 million mortgage applications (from several thousand lenders) for the study across the country’s 100 largest cities.
So, what did Lending Tree’s study reveal?
Key Findings From Lending Tree’s Study
The Good News from Lending Tree’s study is that nearly 75% of all mortgage refinance applications were approved across the country during 2018.
For the 25% of mortgage applications that received a denial, the top four reasons these applications were not approved were as follows:
- An excessive Debt-to-Income (DTI) ratio reflected more than a quarter of all the denied mortgage applications.
- Poor or unacceptable credit history/profiles accounted for nearly another quarter of all the denied mortgage applications. If the mortgage application was based on a credit decision, the lending institution is required to send notice, i.e. a Statement of Denial or Adverse Action Notice. This details how your credit profile impacted the lender’s decision to deny the mortgage application.
- Income applications reflected about 17% of mortgage application denials.
- Unacceptable collateral accounted for about sixteen percent of mortgage refinance rejections.
Although the following reasons for a mortgage denial did not make the top four list, these reasons are also common reasons for mortgage applications to be denied:
- Down Payment, for purchases, does not meet mortgage program guidelines.
- Loan-to-value (LTV – Mortgage Amount Divided by Property/Appraised Value) does not meet mortgage program guidelines.
- An unexpected change in job status during or at the end of the mortgage process.
- Unexplained large deposits in bank accounts, among others.
Also, Lending Tree also notes in its study that these metropolitan areas are where mortgage applicants are most likely to receive approval for their mortgage refinance –
|City||Approval Rate||Leading Cause of Mortgage Denials|
|Ogden, Utah||83.8%||Credit history at 25.6%.|
|Madison, Wisconsin||82.9%||Debt-to-Income (DTI) ratio at 31.4%|
|Provo, Utah||82.9%||Debt-to-Income (DTI) ratio at 26.8%.|
Conversely, the following cities are where it was most challenging to receive a mortgage approval:
|City||Approval Rate||Leading Cause of Mortgage Denials|
|El Paso, Texas||62.9%||Credit history at 28%.|
|McAllen, Texas||64.4%||Credit history at 31.2%.|
|Miami, FL||65.6%||Debt-to-Income (DTI) ratio at 32.6%.|
If you have received a mortgage declination letter, you know how disappointing that moment can be – especially when you consider the amount of time and effort required to submit a mortgage application appropriately and in good faith.
However, if you have been declined for a mortgage application, the good news is most borrowers can make modifications and adjustments that allows them to overcome most of the issues that cause mortgage denials. It merely requires you, the borrower, to reframe the situation, and instead of reacting to the denial and ending it there, decide to learn why the denial occurred and how to overcome it.
Just because a borrower was denied once does not ensure they will be denied again. Remember, lenders are required to delineate the reasons for the denial by way of a formal rejection letter, which offers you, the borrower, a road map back towards a mortgage approval.
Let’s review the reasons for a mortgage application denial and how you can overcome the denial issue.
Common Reasons Mortgage Loans Are Turned Down
Excessive/Unacceptable Debt-to-Income (DTI) Ratios
Mortgage underwriters utilize Debt-to-Income (DTI) ratios as one of the fundamental criteria to determine if a borrower earns enough income to support the newly-applied-for housing debt (PITI of the requested loan amount) and any other monthly obligations the borrower may have, like:
- Car loans.
- Student Loans.
- Alimony/Child Support.
- Credit Cards.
- Other mortgages, to name a few.
In layman’s terms, the DTI ratio is a mathematical calculation that determines if a borrower’s income is sufficient to pay his or her monthly obligations.
When living expenses reach stratospheric levels, like in San Francisco, New York City, San Jose, California, or Boston, Massachusetts, the DTI ratio can (and often do) become a huge barrier for borrowers to overcome.
There are only two ways to impact a DTI ratio positively:
- Increase income:
- Grabbing overtime or additional shifts from a current job.
- Picking up a 2nd job.
- Adding a co-borrower with good credit and acceptable debt levels, among other options.
- Decrease monthly obligations by paying down debt and choosing to proactively limit spending.
However, these changes must be done before applying for a mortgage if they are to bring about a mortgage approval.
A Poor Credit History or Credit Profile
A credit profile helps provide a lender with a picture of how you managed your credit obligations/potential credit during the past. And, like most human behaviors, the best predictor of future behavior is relevant past behavior – which is why your credit score and credit profile play such a key role in determining your mortgage approvability.
Credit scoring is a complex algorithmic process but is impacted by these five top relevant factors, according to Experian.com:
- One’s payment history is the single most important factor that determines credit scores, accounting for 35% of a FICO Score.
- Credit Utilization accounts for 30% of your FICO score. Credit utilization is calculated by dividing the total of all credit card balances with the total of all the maximum credit limits. Here is an example:
The following is an example of a person’s accumulated credit cards:
|Card||Balance||Maximum Credit Limit|
|Credit Utilization Ratio||= 3500/15000||23.3%|
- The length of one’s credit history accounts for about 15% of one’s FICO score. The longer one manages their credit appropriately, the higher one’s credit score climbs.
- Credit mix accounts for about 10% of one’s FICO score. Credit scoring algorithms prefer borrowers with a diverse credit portfolio.
- New credit accounts and inquiries (creditors actively looking into your credit to make a credit decision) account for 10% of one’s FICO score. Excessive inquires and new accounts can impact a credit score negatively, and often does.
According to the folks at Experian.com, credit utilization ratios that exceed 30% (that is, borrowers who maintain credit card balances that exceed 30% of the available maximum credit line) are viewed negatively.
The good news is that in our 21st century world, obtaining information regarding the contents of your credit report is not only easy; it is mandated by federal law.
The reality is that only once a borrower understands why their credit score is so low can they begin to correct it. Note, time is often your best advocate when looking to improve your credit score.
Incomplete Mortgage Applications
As noted above, income applications reflected about 17% of mortgage application denials. However, this statistic may be a bit misleading because borrowers sometimes apply to several lenders at once and then abandon the other mortgage applications (which remain incomplete from the other lenders’ perspective) when making a final lending decision.
If a mortgage application is declined due to its incompleteness and is not just abandoned for another mortgage offer, an incomplete application:
- Has missing information relevant to the credit decision.
- Contains information that has not or cannot be verified according to acceptable financing standards.
Lenders requiring additional information to make a credit decision must send written notice to mortgage applicants, offering the borrowers ample time to respond.. Should the borrowers fail to respond, a lender has no further obligation but to send a credit denial letter for an incomplete application.
Perhaps of all the mortgage denial reasons, borrowers should recognize that this one denial should really never happen. If borrowers are serious and remain committed to the mortgage application process, then complying with the provision of additional documents requested by the mortgage lender should be a no brainer.
Unacceptable Collateral or Property
A mortgage loan is debt is secured by real estate, offered as collateral should a borrower default on the outstanding mortgage. There are countless reasons that a property might not conform to a mortgage underwriter’s approval criteria; however, the main reasons might include the following:
- An appraised value that is lower than anticipated, which creates an LTV (loan-to-value) that exceeds program limits.
- The property’s systems do not meet current building code requirements, or there is uncurable obsolescence.
- The property is located within the boundaries of CERCLA (Superfund) site, among many others.
Most refinance mortgage applications that are declined for unacceptable collateral reasons are often the result of an undervalued property. Here is a quick example:
A borrower applies to refinance their $200,000 mortgage, which currently has a rate of 5% fixed for 30 years. At application, the borrower indicates that the approximate value of the subject property is $300,000, which calculates to an LTV of 72.72% ($200,000/$275,000).
However, when the appraisal was completed during the mortgage refinance process, the value of the property was estimated a $225,000, which calculates an LTV of 81.63% (200,000/245,000). Clearly, an LTV of nearly 82% would require the borrower to either pay mortgage insurance or pay down the mortgage to 80% of $245,000 or $196,000 (80%*$245,000).
Interestingly, many financial whizzes would encourage a borrower (who happens to have the $4K to avoid needing private mortgage insurance (plus the cash to close)) to opt for the lower interest rate/term because, in the long run, the savings would be significant.
However, if you do not have the available funds, then you can either wait until you pay down the mortgage over time, or the property inherently appreciates, as real estate often does.
Other Common Reasons for Mortgage Application Denials
Down Payment is Too Small
A down payment mortgage issue is actually the flip side of the LTV issue, noted above, only in terms of a purchase money mortgage. Concerning down payments, the larger one’s down payment, the more likely they will be to receive a mortgage approval.
Inadequate/Unacceptable Employment History
Underwriters prefer to see a consistent employment history as it is indicative of a stable borrower. Most lenders want to see a solid two-year work history unless a borrower is a recent graduate and just entering the workforce.
If you, as a borrower, have received a denial for a home mortgage submission, it is important not to be deterred because with some patience and a bit of extra work; you just might have the ability to transform your creditworthiness to one that is easily recognized and approved by credit underwriters.
Before you make any financial decisions that may have some sort of impact on your financial circumstances, it is smart to talk with a trusted financial advisor or mortgage professional. They can often help you refine your thinking to ensure you do not do anything that might hurt your chances when applying for a mortgage loan.