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 pump the brakes, just a bit. There’s one last hurdle you’ll need to go through. 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.
You may be wondering how often an underwriter denies a loan. According to mortgage data firm HSH.com, about 8% of mortgage applications are denied, though denial rates vary by location.
To avoid falling into that percentage of hopeful buyers, it’s important to understand how underwriting works, the top reasons why mortgage loans are denied in underwriting and tips for preventing loan denial.
How Underwriting Works
The underwriting process happens when the lender verifies your income, assets, debt and property. This information is needed to ensure you’re in a good position to take on the financial responsibilities that come with a mortgage and that it’s a good investment for the lender. It helps 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 and 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.
What About Pre-Approval?
Getting preapproved for a mortgage doesn’t guarantee a future clear-to-close decision from the underwriter. This type of approval is based on basic information you provide and does 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. It typically won’t verify that information by looking at financial statements or other documents.
Can An Underwriter Deny An FHA Loan?
7 Reasons Why Mortgage Loans Are Denied In Underwriting
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 (DTI) Ratio Is Too High
Your DTI 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%.
If you have a lot of debt, work on paying it down before applying for a mortgage. And once you’re in the process of getting one, don’t add more debt by making any big purchases.
3. The Loan-To-Value (LTV) Ratio Is Too High
LTV compares your mortgage balance to the value of the home. When 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 cannot 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. 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. You could get fired. Or, maybe you accepted the job for a lower income, 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 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 are transparent with your lender and communicating 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
Large deposits, especially from unknown sources, can raise some red flags. It 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 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 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. The Appraisal Is Too Low
A lender cannot lend more than the appraised value of the home. If the appraisal 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 continue to make all of your payments on time, refrain from making large, questionable deposits, don’t take 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, 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
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 make sure you have enough money saved for a down payment and closing costs, have a strong credit score and are in a stable job. Education 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. Our Learning Center is a great place to start your education.