Underwriting: What It Is And Why Underwriters Deny Loans
Rejection hurts. And it’s even more upsetting when it gets in the way of buying your dream home.
Once you get your offer accepted, it may feel like there’s nothing that’ll stop you, But there’s one last hurdle you’ll need to go through before everything’s final. It’s called the underwriting process, and it’s used to determine whether your loan application – and your chances of buying the home you want – will be accepted or rejected.
It’s important to understand how underwriting works, the top reasons why mortgage loans are denied in underwriting and some tips for preventing loan denial.
What Is Underwriting And How Does It Work?
Mortgage underwriting is the process of verifying and analyzing the financial information you’ve provided to your lender.
The underwriting process happens when the lender verifies your income, assets, debt, credit and property. This information is needed to ensure you’re in a good position to take on the financial responsibilities of a mortgage and that it’s a good investment for the lender. In short, it helps your lender assess the risk of lending to you.
Underwriting occurs once you’ve completed your mortgage application and all required documents are turned in for the underwriter to review. Requested documents may include:
- Bank statements
- W-2s and other tax documents
- Recent pay stubs
- Copies of forms of identification, like your driver’s license, military ID or Social Security card
- Letters of explanation or gift letters, when necessary
The underwriter reviews these documents to verify your income and job stability as well as your ability to handle debts, keep up with mortgage payments and afford the closing costs, fees and mortgage loan.
As you undergo the underwriting process, your loan will go through one or more of these steps:
- Conditional approval happens when all of your documents are turned in and undergoing review, and the underwriter feels that most of your information looks good. However, there are still a few conditions that must be met before your loan is approved.
- Approval occurs when everything has been verified by the underwriter and you’re cleared to close on your loan.
- Denial happens when the loan application is denied and you’re refused a mortgage. This may happen for several reasons, which we’ll explore later.
Preapproval For Underwriting
Getting preapproved for a mortgage doesn’t guarantee a future clear-to-close decision from the underwriter. This type of approval is sometimes based on basic information you provide, and may or may not require digging as deep into your credit report or finances as underwriting will.
The lender will perform a credit check, ask about your financial situation and review certain pieces of information, including your income and assets.
However, not all preapprovals are the same. The situation we’ve described with minimal if any financial checks is a Prequalified Approval, which is useful if you just want to get an idea of what you can afford –but we recommend all of our clients get a Verified Approval.1
A Verified Approval involves pulling your credit report to get a look at your outstanding debt. In addition, we verify income and assets using documents like W-2s, 1099s, bank and investment account statements. A Verified Approval can help you make a confident offer on a home with a much better idea of what you can afford.
How Often Does An Underwriter Deny A Loan?
You may be wondering how often an underwriter denies a loan. According to the mortgage data firm HSH.com, about 8% of mortgage applications are denied, though denial rates vary by location. While FHA loans have different requirements that may make getting the loan easier, an underwriter may still deny an FHA loan for the same reasons they deny other loan types.
8 Reasons Why Mortgage Loans Are Denied In Underwriting
It’s important to understand why a loan application is denied to help you secure your financing. The following are several common reasons why underwriters deny loans and how you can help prevent them from happening.
1. Your Credit Score Is Too Low
A low credit score might indicate that you’re a high-risk investment who may have trouble making on-time payments or handling the financial responsibilities of the loan.
Before applying for a mortgage, review your credit score and credit report. Make sure you dispute any errors. If your credit score is low, you may want to work on increasing it before applying. If you have a qualifying credit score, make sure you don’t do anything during the mortgage process to cause it to drop, like miss a payment or max out a credit card.
2. Your Debt-To-Income Ratio (DTI) Is Too High
Your DTI ratio helps lenders determine whether you’ll be able to take on more debt. If your DTI is high, you may not be able to afford your mortgage. Most lenders require a DTI of less than 50%. For the most possible lending options, it’s a good idea to keep DTI at or below 43%.
If you have a lot of debt, you should work on paying it down before applying for a mortgage. And once you’re in the process of getting one, it’s best not to add more debt by making any big purchases not related to your buying of the home itself. By eliminating some of your debt, you’ll increase your cash flow and prove to a potential lender that you have enough money coming in to pay a mortgage.
3. The Loan-To-Value Ratio (LTV) Is Too High
LTV compares your mortgage balance to the value of the home. When you're buying a house, your LTV is brought down by your down payment. Certain loans require specific down payments and LTVs. For example, a conventional loan requires a minimum down payment of 3% or 97% LTV. If you can’t afford the minimum down payment, you won’t be able to get the loan.
To help avoid this issue, take the time to save up for a down payment of at least 3 – 3.5% depending on your loan. Not only will a larger down payment help you get better interest rates and more mortgage product options, but it will also show lenders that you’re capable of saving. For people who are self-employed or who have other negative circumstances, a large down payment can overcome worries from a nervous lender.
You could also look into down payment assistance programs if you need more help.
4. Your Employment Status Recently Changed
Lenders like to see financial stability. When you’re getting a steady paycheck, you’re more apt to make your monthly payment. If you lost your job recently, a lender may question whether you can afford a mortgage right now.
And a new job can come with a lot of uncertainty – you might hate it and quit, or you could get fired. Maybe you accept a job with a lower salary, which can also affect your loan approval.
If you’re switching from a job in the same field and with equal or greater pay, this typically won’t be an issue. If that’s not the case, you can prevent this from being an issue by staying at your current job until after you close or by waiting to apply for a mortgage until you’ve been at your new job for at least a few months. If you can’t do either and want to get a mortgage with a new job, just make sure you’re transparent with your lender and in communication with them on this change. You may also provide additional documentation to help, including your offer letter and Verification of Employment (VOE) from your employer.
5. You Have Unusual Bank Account Activity
As mentioned above, buying a home comes with many costs you need to pay for on top of the mortgage, including closing costs, insurance premiums, taxes and homeowners association fees. In many cases, your lender will want to see that you have enough money in the investment bank to cover these expenses for up to 6 months.
However, large deposits – especially from unknown sources – can raise some red flags. These could indicate that you took out a loan to pay for a down payment, which will add to your DTI.
If you receive a large amount of money as a gift, you can provide a gift letter from the donor explaining that the money was a gift and does not need to be paid back.
6. There Are Problems With The Property
The results of an inspection can also make or break your chances of getting a loan. For example, if you’re getting an FHA loan, the home must meet certain guidelines to qualify for the loan. If the property fails, your FHA loan will be denied. If an appraisal inspection uncovers a major issue, like a bad foundation, the loan may be denied as the home would be seen as a bad investment.
To help prevent this from happening, make sure you walk through the home in person and read the housing disclosures carefully. Make sure you get an inspection on the home early to avoid wasted time.
7. You Have A History Of Missed Mortgage Payments
If you’ve previously been a homeowner, your underwriter will want to see evidence that you paid your mortgage consistently and on time, otherwise they may not feel it’s worth the risk to approve your loan for this new home.
8. The Appraisal Is Too Low
A lender cannot lend more than the appraised value of the home. If the appraisal value comes back lower than the sale price, you’ll either need to pay the difference out of pocket or renegotiate to a lower price. If you can’t do either, your loan will be denied.
What To Do Next
Here’s what to do after reaching conditional approval or receiving a mortgage rejection.
When You Receive Conditional Approval
At this stage, you’ll likely be asked to provide more documentation. Make sure you respond to these requests as fast as possible to keep the process going. The underwriter cannot proceed until you turn in the requested documents. Make sure you’re open and honest about any issues that come up.
During this crucial time, you don’t want to do anything that could put your loan in jeopardy, so you should continue to make all of your payments on time; refrain from making large, questionable deposits; avoid taking out any loans and stay away from using credit to make big purchases.
When Your Loan Is Rejected
If your loan application is rejected, there are a few steps you can take to put yourself in a better position to get a mortgage in the near future. First, you should understand why your loan was denied, then work to fix those issues.
If your DTI was too high, work on paying down your debt. If your credit score was too low, continue to make your payments on time, pay down some of your debt and check your credit report for any errors. If your LTV was too high, take this time to save for a down payment.
How To Prevent Loan Rejection: Tips For Getting Approved
On top of the tips already discussed, there are a few other actions you can take to try to avoid having your underwriter deny your loan. Here are a few additional measures you can take to increase your chances of getting approved faster:
- Ask someone to co-sign. If your profile isn’t as substantial as you’d like it to be, a co-signer can help strengthen your case for a loan. Be aware that you’re asking someone to put their credit score on the line, so you should confirm that you’re able to make all the payments on time and in full. There’s nothing more guaranteed to destroy a relationship than ruining someone’s finances. Check with your lender about the guidelines for a particular mortgage product you’re interested in, as there may be requirements or restrictions when a co-signer is involved.
- Be prepared to apply. Lee Huffman of Bald Thoughts says it helps to have all your necessary documents ready for your mortgage loan The faster you can respond to requests for more information, the faster your request will be approved. According to Huffman, an applicant will need their two most recent paystubs, the previous 2 years’ W-2s and tax returns, 2 months of bank and investment statements, their insurance bill, their property tax bill and their most recent mortgage statement.
- Look for less than you can afford. Many people try to buy a house with the maximum amount of money a lender will give them. Try to apply for a loan that’s less than what you might be approved for. This way, you’ll have more leeway in your budget and will have a better ability to repay the loan.
What Documents Are Needed For The Underwriting Process?
Let’s go through each of these so you understand what happens during underwriting and the materials you’ll need to provide during the process.
While the underwriting process is happening, your lender will order an appraisal of the home you wish to purchase. The purpose of the appraisal is twofold: It protects you from overpaying when you’re buying a house, and it protects the lender and investor (Fannie Mae, Freddie Mac, FHA, etc.) from lending more than the value of the house.
Because the house serves as collateral for the loan, it’s necessary that the investor be able to recover invested capital if the borrower defaults on the loan. In other words, the lender wants to be sure that if you default, it can sell the house to recover what you owe on the mortgage loan.
Underwriters will also look at documentation verifying any saved assets you may have such as checking and savings accounts, stocks, bonds and proceeds from the sale of tangible items. When an underwriter reviews your assets, they look to make sure the money is actually yours, and not just a loan from someone else.
Your underwriter may also check to make sure you have cash available for reserves. Reserves are measured in terms of the number of months you could make your mortgage payment if you lost your income.
Underwriters take a close look at your credit history. They want to know, of course, whether you have paid and continue to pay your bills on time. But underwriters also need to be able to review any documents detailing how much other debt you owe, in the form of car payments, student loans, credit card debt or other liabilities.
Even if you’ve been keeping up with all your payments, too much debt relative to your income – often referred to as your debt-to-income ratio (DTI) – is a strong indicator of future financial difficulty.
Additional Documentation Needed
An underwriter may also require you to provide other pieces of information to gain a more comprehensive understanding of your financial history.
For instance, legal documents that verify court-ordered debt – like alimony or child support – might be necessary to complete the underwriting process for your mortgage loan. Be sure to also have any divorce decrees, court orders or letters from friends of the court that may have an effect on your overall financial situation.
If you’ve previously rented property, some mortgage programs require records of your rent payment history for at least 12 months to be provided during your underwriting process.
How Long Does Underwriting Take?
If all your paperwork is finished and all of the proper documentation is provided, the underwriter could finish their work within a couple days. However, if the information you’ve shared with them is incomplete in some capacity, you’ll need to fill any informational gaps and provide your underwriter with any additional materials they’ll need to verify all aspects of your financial history.
To make sure this process runs as efficiently as possible, you should understand what is expected of you from the lender, and don’t try to hide any less-than-perfect components of your financial records from the underwriter.
The Bottom Line
By making sure you’re in a good place financially before you apply for a loan, you’ll have a better chance of having your loan approved. To do this, you’ll want to check that you have enough money saved for a down payment and closing costs, with a strong credit score and a stable job.
Educating yourself is also important. By learning more about the mortgage process and how to purchase a home, you can be better prepared when the time comes. Check out more home buying content in the Quicken Loans® Learning Center to start your education today.
1 Participation in the Verified Approval program is based on an underwriter’s comprehensive analysis of your credit, income, employment status, debt, property, insurance, appraisal and a satisfactory title report/search. If new information materially changes the underwriting decision resulting in a denial of your credit request, if the loan fails to close for a reason outside of Quicken Loans’ control, or if you no longer want to proceed with the loan, your participation in the program will be discontinued. If your eligibility in the program does not change and your mortgage loan does not close, you will receive $1,000. This offer does not apply to new purchase loans submitted to Quicken Loans through a mortgage broker. Additional conditions or exclusions may apply.
2 Rocket Homes® is a registered trademark licensed to Rocket Homes Real Estate LLC. The Rocket Homes® Logo is a service mark licensed to Rocket Homes Real Estate LLC. Rocket Homes Real Estate LLC fully supports the principles of the Fair Housing Act. For Rocket Homes Real Estate LLC license numbers, visit RocketHomes.com/license-numbers. California DRE #01804478
3 Quicken Loans, LLC (doing business as Rocket Mortgage) and Rocket Homes Real Estate LLC are separate operating subsidiaries of Rocket Companies, Inc. (NYSE: RKT). Each company is a separate legal entity operated and managed through its own management and governance structure as required by its state of incorporation, and applicable legal and regulatory requirements.