Rebounding From a Home Loan Rejection

First dates don’t always result in marriage and the same is true with a home loan application.

Lenders have different requirements for home buyers and people looking to refinance a mortgage, which can make finding the perfect match difficult.  Not every borrower is appropriate for every lender.

Borrowers don’t have to take “no” for an answer. They can apply with a different lender, improve their credit or do a number of other things to get over a home loan rejection.

Why a home loan rejection?

Once they’ve been denied for a loan, borrowers have a legal right to know why they’ve been rejected. A denial letter with the reasons for the rejection should arrive in the mail, although it may not list specifics. Applicants can ask their loan officer for an explanation of the reasons listed for the denial.

Can’t document your income

There may be several reasons why borrowers are rejected for home loans.  One of the most common reasons is that their income isn’t documented properly. Even with a high credit score and a lot of money in the bank, not being able to prove your income to a lender is an easy way to get rejected.  Simply having your tax records available should resolve this.

Other income issues that could tie up a mortgage application include switching jobs often, employment gaps or not having worked in the same industry for two consecutive years.  Changing from a salaried position to commission-based work can also make it difficult to track your earnings history.

Cash reserves are important as well. Documenting through your tax returns that you can weather a financial storm such as a tax increase to pay for home upkeep, property taxes and can afford a monthly mortgage is important too.

Compensating factors

If you’re on the border of qualifying for a mortgage, there are some “compensating factors” that you can improve on to make the lender more willing to approve you for the loan.

These include having: a down payment of more than 20%, a loan-to-value ratio of less than 80%, a year or more of cash reserves,  or a credit score of 740 or better.

If your application isn’t perfect, these compensating factors could help to make it shine.

Low appraisal

If the home you’re seeking isn’t worth as much as the loan, then denial is almost automatic. It may be a home you’re in love with and are willing to overpay for but a bank is unlikely to agree.

The loan-to-value ratio or LTV, is a risk assessment ratio that lenders look at. A high LTV is seen as a high risk and is unlikely to be funded. An approved loan with a high LTV could cost the borrower more or require them to buy mortgage insurance.

Here’s an example: If you need to borrow $92,500 for a $100,000 property, the LTV will be 92.5%. That’s higher than the 80% LTV ratio most banks allow. Also if the home appraisal is too low, the LTV ratio can increase. A second appraisal with the same lender isn’t permitted as a way to get a higher appraisal. However, you can appeal the appraisal if you believe it is inaccurate. In this case, your lender may request the appraiser to reassess their original valuation if they believe there are any material errors. Another option is to work with a different lender and ask for a new appraisal.

Credit problems

As we mentioned under compensating factors, improving your credit score can bump you up enough to be approved for a home loan.

Doing just a few things can be enough to improve your credit score and credit history in one to three months. You can pay off your credit cards and may see your credit score go up by as much as 30 points. At the very least, keeping low balances on credit cards may help as well. Ask your lender to get a rapid re-score to get your new score within a few days of paying off your credit cards or having reduced balances. This expedited reporting system can keep you from having to wait a few months to get approved.

Don’t apply for credit cards or new accounts within six months of applying for a new home loan. By the same token, you may not want to close any accounts you have either. The idea is to keep things as they are. These types of actions may affect your score negatively and cause you to be declined for your mortgage.

Lower debt-to-income ratio

The rapid re-score can also be used to check if you’ve lowered your debt-to-income ratio. The formula is used to compare your monthly debt obligations to your income.

Paying off your debt, including credit cards and other bills, can lower the ratio to below your lender’s limit. Fannie Mae has a guideline of up to 45 percent debt-to-income ratio for its loans, though individual banks may have lower limits.

All of this can be difficult to do on your own after you’ve had a home loan rejection. Start by talking to your loan officer or lender to see what their recommendations are. Some unknown issue may be a red flag that you can quickly work on to turn this into an approval for your home loan.