Why Loans Are Denied In Underwriting And What To Do Next
Sidney Richardson7-minute read
May 11, 2021
Being turned down by a mortgage lender, especially after preapproval, can be a huge disappointment. If this has happened to you, however, don’t give up hope – let’s take a look at why your mortgage might have been denied and your options for improving your credit so you can reapply and ideally get the house (and loan) of your dreams.
4 Reasons Why An Underwriter Might Deny Your Mortgage Loan
While credit issues are a common reason why people might be denied a mortgage, they’re not the only reason. Here are a few more that may hamper your efforts:
If you don’t yet have a significant credit report, you will likely be denied. The first step to fixing this issue is to start building upon your credit history so that your lender has some idea of how you manage credit and debt. They want to see that you can responsibly pay it back.
You can also be denied for having insufficient income. Lenders will calculate your debt-to-income ratio (DTI) to make sure that you have adequate monthly income to cover your house payment, in addition to other debts you might have. If your DTI is too high or your income isn’t substantial enough to prove you can handle the monthly payments, you’ll be turned down.
A Job Change
If you just got a new job, you can sometimes be denied for that reason, too. Lenders prefer stability in both your income and your job. With a new job, they might worry that you won’t have the same income potential you’ve shown in the past, which can make them wonder if you’ll be able to repay your mortgage. While it’s not required, typically lenders prefer you’ve been with the same employer, or in a very similar position, for at least 2 years.
An Unexplained Cash Deposit
What could be wrong with too much cash? Well, if a mortgage lender sees a recent cash deposit, granted it’s sizable enough, they might be worried that you were gifted the money and might have to pay it back. They’ll want to know the source of any funds to feel fully confident lending you money.
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When Denial Happens During The Mortgage Process
One of the reasons it’s important to apply for a mortgage prequalification is that it can give you a view into whether your application will ultimately be accepted or denied. However, in rare instances when your situation changes drastically between a prequalification and the mortgage closing, it’s possible to be denied at closing. To help prevent that, keep in close contact with your lender throughout the process so they can help you avoid actions that can adversely affect your ability to get a mortgage.
What To Do If Your Home Loan Is Denied
If you were denied a mortgage, don't give up hope. There are a few things you can do now to make your application stronger for when you’re ready to try again.
Talk To Your Lender
The first step is to return to the source. If anyone knows why you’ve been denied a mortgage, it’s going to be your lender. And according to the Equal Credit Opportunity Act, lenders are required to tell you why you’ve been turned down, if credit played a role. They must include a letter with the specific details, as well as the name of the credit reporting agency that supplied the information they were using. That can help pinpoint the areas where you might need to change some habits to shore up your credit.
But remember, that’s just the first step. If you believe the letter was vague or inaccurate, contact your lender to explain your misgivings. They want your business, so they’ll be eager to have a conversation and help you dig up the root of your credit issues.
Establish Credit History
If you're a first-time home buyer, it's possible that you might not have built sufficient credit history to satisfy your lender's requirements. If that's the case, it might just be a matter of time before you're ready to apply, but if you need to kickstart your credit, you can try one of these options:
- Secured credit cards allow you to start using credit that is secured by your own funds. After building up your score by responsibly using a secured card, you can graduate to traditional credit.
- Becoming an authorized user on a parent or other family member’s credit card can help you reap the benefits of their good credit.
- Credit-builder loans are personal loans secured by your funds and repaid in installments. Like a secured credit card, these help you slowly demonstrate your creditworthiness.
Fire Up The Credit Monitoring
Not new to credit, but trying to buy a home with bad credit? The best way to get the ball rolling on rebuilding credit is by monitoring it. Check your credit report and score regularly – there are various online sources where you can do this for free. You should also track your monthly debts and credit utilization to see where you need to make changes to improve your score. Having more insight into your credit on a regular basis will help you with everything we’re going to discuss in the upcoming sections.
Check For Errors In Your Credit Report
Between the credit bureaus and the creditors that play a part in developing your credit report, mistakes are bound to happen every now and then. These errors can lower your credit score and be a big headache to fix.
Common errors include outdated information, incorrect payment statuses, wrongfully duplicated negatives, and most importantly, fraudulent accounts. You should eliminate any chance of error by sifting through your credit report with a fine-toothed comb. If you find anything that looks unusual, take the proper steps to dispute your credit report.
Pay Down Debt
One of the best ways to improve your score is to pay down any debts and pay off any collections showing on your credit report. If it’s unrealistic for you to pay off the entire balance, try to work out an arrangement with creditors to pay what you can, which will show up on your credit report as “paid as agreed.” While it won’t raise your credit score as much as paying off the debt in full, paying something is better than nothing.
Keep Accounts Open
When you pay your debt down, try not to close the accounts. This could hurt your score because you want to have a variety of accounts open, particularly ones that have been open a long time, to show the fullest extent of your credit history. It can be beneficial to have a mix of credit cards, auto loans, student loans and potentially personal loans to show you’re adept at handling credit.
While you want to pay down debt, it can hurt your credit score to completely close an account because it will eliminate the amount of credit you have available. If you close an account, even if you spend the same amount on your other credit cards, you’re using a larger percentage of your remaining available credit. That’s what’s known as “credit utilization,” and if you use too much of your credit, future creditors may be hesitant to extend loans and other credit to you.
Pay On Time
Another factor lenders look at when you apply for loans is whether you make payments on time. Paying your bills and debts off when they’re due will improve your score, while a history of late payments will reflect poorly on your credit.
Diversify Your Debt
As mentioned, another big key to increasing your score is to have a good mix of revolving credit debt and items like installment loans, such as an auto or personal loan. Mortgage lenders want to see that you can effectively manage different types of debt. Just make sure to pay them on time and don’t take on more than you can handle.
Increase Your Credit Limits
A good second phase of your credit score rebuild after you’ve shown your hard work is to try and get your credit limits increased. For example, if you currently have a $500 credit limit, a lender might be willing to increase it to $1,000 once they see the strides you have made.
Keep Credit Utilization Low
In order to keep your credit score high, you don’t want to use too much of it, as this can be a sign of financial stress.
Your credit usage is monitored in the form of “credit utilization,” which displays your current debt as a percentage. For example, if you have one credit card with a $1,000 limit and another with a $3,000 limit and total carryover balances of $800 per month between the accounts, your credit utilization would be 20% ($800/$4,000). Experts usually recommend using no more than 30% of your overall credit limit between all of your accounts.
Build Your Application Before Reapplying
If your application was denied, remember that there are likely multiples steps you need to take to repair it. There are few ways you can immediately rectify the issues an underwriter finds in your mortgage application. If the fixes were quick – if you were missing some information, for example – your underwriter would likely have granted conditional approval.
If you’re denied a mortgage, it will probably take some time to fix up your application, so don't expect to reapply immediately without addressing the issues that came up the first time around.
Don't Worry About Past Denials
You might worry that your mortgage denial will leave a trail should you attempt to try again; the good news is that while your credit report will reflect that you applied, it doesn’t show that you were denied. And it will only mildly impact your credit – it will show as a “hard” pull, meaning that others will see that you were applying for credit, but servicers understand that can happen when you’re shopping around. In other words, being denied a mortgage shouldn’t impact your credit that severely.
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