Take a minute to think about your dream home. Is it a classic home full of character? Newly constructed modern abode? Located in the heart of a hustling city? Or situated in a quaint little town you’d see in a Hallmark movie? Whatever your dream home looks like, there’s no better feeling than finally finding it and knowing it’s “the one.”
But what happens if you get denied for a mortgage loan to purchase this home? Unfortunately, it happens more than you may think. According to a NerdWallet report on mortgage application data, 8% of mortgage applications were denied in 2020 – a substantial 58,000 more denials than just a year prior1. Naturally this begs the question, “Why do people get denied mortgages?”
We’ve outlined 5 common reasons for home mortgage loan denial below.
- Unfavorable debt-to-income ratio (DTI)
Let’s start with the biggest culprit for mortgage denials – an unfavorable debt-to-income ratio (DTI). According to the NerdWallet report, 32% of all mortgage application denials in 2020 were due to objectionable DTIs1. So what exactly is a DTI? Simply stated, a DTI is monthly debt payments (such as an existing mortgage, credit card payments, auto or other loans) divided by gross monthly income. A solid risk indicator, the DTI ratio helps lenders determine whether a borrower has too much debt or not enough income. While DTI ratios can certainly vary, a good rule of thumb is to have a DTI less than 36%.
In assessing DTI, lenders are ultimately looking to determine whether a borrower will be able to take on more debt – in the form of the mortgage payment. Rule of thumb here states that mortgage payments should not exceed 28% of monthly gross income.
- Low credit score
So what’s the number two reason for mortgage application denials? You may have guessed it – a subprime credit score. In fact, according to the NerdWallet report, low credit score was responsible for 26% of denials in 20201. While the average FICO score in the US was 714 in 20212, many Americans have no idea where they stand when it comes to credit score. Often one of the first factors lenders consider, a low credit score may signal that a borrower has trouble making payments on-time and therefore may struggle to handle the financial responsibilities of the mortgage.
- No/insufficient credit history
Speaking of credit scores… having no credit or an insufficient credit history is also a reason for a mortgage denial. While 83% of Americans own at least one credit card3, there are still people who prefer to make purchases almost exclusively via cash, check, or debit card. And while this is certainly a way to avoid debt accumulation, it’s important to realize that not all debt and credit card use is bad. When it comes to applying for a mortgage, borrowers need to have established credit to show the lender their ability to take on debt and pay it off responsibly.
- Limited down payment and closing funds
When it comes to buying a house, perhaps some of the most significant expenses incurred are the down payment and funds required for closing. Once a borrower supplies financial information to their lender and reviews the loan program, there will be a clearer understanding of what each of these figures will cost. In terms of the down payment, a lender looks at this initial payment as a borrower’s investment in their future home. The old saying, “bigger is better” rings especially true here – the more a borrower can put down, the more the lender’s mind will be put at ease. When it comes to closing costs, lenders want to ensure that the borrower has ample funds to cover these expenses. If a borrower is unable to come up with these funds on their own, the chances of mortgage loan denial increase.
- History of missed payments
One of the key characteristics lenders look for in borrowers is responsibility – especially when it comes to making payments on time. For borrowers who have previously owned a home, the underwriter will assess whether or not you were able to pay your mortgage consistently and on-time. Too many late payments not only jeopardize approval for the loan, but could also substantially harm a credit score. If a borrower has a short sale or foreclosure on record, this may also prevent them from getting approved for a certain length of time. The takeaway here – prompt, persistent payments are top priority.
If you’ve been denied a mortgage, be sure to carefully review the loan rejection letter. Knowing why you were denied is essential in being able to take the proper steps and corrective actions to avoid being denied again in the future. After all, it’s not just about getting approved for a new home – it’s also about getting approved for the most favorable and affordable loan programs.
An Alternative Solution
Even if you fall into any of the categories listed above and don’t qualify for a regular “forward” mortgage, that does not mean that your dream home is out of reach. Fortunately, for homeowners ages 62 and older there is another solution – a Home Equity Conversion Mortgage (HECM) for Purchase.
A HECM for Purchase is a reverse mortgage specifically designed to help boost purchase power to buy the home you need – while meeting your financial and retirement goals. This type of loan helps you accomplish two goals with a single transaction – buying a new home while securing a reverse mortgage. Many seniors like this option because it can help save money by reducing closing costs since a single loan is taken out.
While traditional ‘forward’ mortgage eligibility is heavily based on credit score and financial standing, the qualifications for a HECM for Purchase are quite different. Since monthly mortgage payments are optional4 on a HECM for Purchase, having a high credit score is not necessary to qualify for the loan.
In order to qualify for a reverse mortgage, you must simply live in your home as your primary residence, have sufficient equity in your home, and continue to keep up to date with homeowners insurance, taxes, and general home maintenance.
Sound like a good fit? Let’s talk. To learn more about HECM for Purchase and using a reverse mortgage to purchase your retirement dream home, contact the Longbridge team of experts today.
2 What Is the Average Credit Score in the U.S. – Experian
3 30+ Credit Card Statistics : Credit Card Debt, Fraud, Usage, And Ownership Facts – Zippia
4 Real estate taxes, homeowners insurance, and property maintenance required.