What should I do if an underwriter denies my loan application?

If you’ve gone through the process of preparing to buy a home, getting preapproved for a loan, seeing houses, and making a successful offer, having your mortgage loan denied in underwriting can feel like a slap in the face.

It’s normal to feel disappointed, but you don’t need to give up hope. Your underwriter should tell you why your loan was denied, which can help you avoid denials in the future.

How often do underwriters deny loans?

If you’re just worried about applying for a loan and haven’t actually received a denial yet, the good news is that it’s rare.

In 2023, the overall denial rate for home loan applications was 9.4%, a slight increase from 9.1% in 2022. FHA loans had a denial rate of 13.6%, while conventional conforming loans had a denial rate of 7.9%.

7 signs an underwriter might deny a loan

Underwriters look at many factors when determining if someone is a good borrower. Problems with credit are one common reason for loan denials, but there are some other signs your mortgage will be denied that might affect your chances of buying a home.

1. Insufficient credit

Insufficient credit can take many forms. If you have a short credit history or a thin file, that can give lenders pause. Similarly, a poor credit score will hurt your chances. Before applying for a loan, try to build your credit history so lenders have some data to look at, or take steps to rebuild your credit and show that you’re serious about buying a house.

2. Insufficient income

Not earning enough money to afford the home you want is also a common reason for denial. Lenders will calculate your debt-to-income ratio (DTI) to make sure you have enough income to cover your house payment, in addition to other debts you might have. If your DTI ratio is too high or your income isn’t substantial enough to show you can handle the monthly payments, you’ll be turned down.

3. Record of late payment

If your credit report shows a history of late loan payments, lenders may worry about your ability to make payments on a new mortgage. Consider setting up automatic payments for your credit cards and other bills to help avoid this issue.

4. High loan-to-value ratio

Your lender also will take your loan-to-value (LTV) ratio into consideration when deciding whether you’re eligible for a loan. Your LTV ratio compares your mortgage principal to the value of the home. The lower it is, the better.

Making a larger down payment is one way to reduce your LTV ratio, so taking more time to save up for a down payment can improve your chances of qualifying for a mortgage.

5. A job change

Getting a new job is exciting, especially if you’re moving up on the career ladder or joining an exciting company. However, it can sometimes be a red flag to lenders because it shows instability.

While it’s not required, typically lenders prefer you’ve been with the same employer, or in a similar position, for at least 2 years.

6. An unexplained cash deposit

Your loved ones may offer to help you with the purchase of a home. It’s a big moment in your life after all, and it’s natural for people to want to help. However, without proper documentation of gifts or other cash deposits to your bank account, this can cause problems.

Lenders might see these deposits and worry that you’re taking on other loans or borrowing money from friends and family that you’ll have to pay back, which can affect your ability to afford the mortgage payment.

If you do receive large cash deposits before buying a home, make sure to have a record of where they came from and documentation or a letter stating you don’t have to pay them back.

7. Inspection issues

When you have your home inspection and a significant issue pops up, you could be denied your mortgage loan. Lenders typically deny your loan if they see the home as a bad investment during the appraisal process. Although it’s not a good feeling to have your loan denied, it might be the best-case scenario. You don’t want to purchase a home laden with problems in need of fixing.

Should I be worried about underwriting?

One of the reasons it’s important to apply for a mortgage prequalification is that it can show you whether your loan application will ultimately be accepted or denied. In rare instances when your situation changes drastically between a prequalification and the mortgage closing, you may be denied at closing. To help prevent that, keep in close contact with your lender throughout the underwriting process so they can help you avoid actions that can adversely affect your ability to get a mortgage.

What to do if your mortgage loan is denied in underwriting

If you were denied a mortgage, you shouldn’t lose 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 ask your lender for the reason behind your mortgage denial. Under the Equal Credit Opportunity Act, they must provide a letter with specific details, including the credit reporting agency they used. This can help you identify how to improve your credit.

For example, if the letter cites a history of late payments, you can work on improving your payment history before you apply again.

However, asking for that letter is only the first step. If you believe your letter is vague or inaccurate, it’s best to contact your lender to explain your concerns. Remember, they want your business, so they should be eager to help you understand the root of your credit issues.

Establish credit history

If you’re a first-time home buyer, you may 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. If  you need to kickstart your credit, you can try one of the following strategies:

• Open a secured credit card: 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.
• Become authorized on a loved one’s credit card: Becoming an authorized user on a parent’s or other family member’s credit card can help you reap the benefits of their good credit.
• Take out a credit-builder loan: 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.

Keep an eye on your credit

Monitoring your credit is important for everyone, but it’s doubly important if you’re looking to apply for a big loan such as a mortgage.

There are many ways to check your credit report and score, and most of these services will give you advice on the factors that are influencing your credit score. Focusing on paying down your existing debts or avoiding late payments can help improve your score.

Keeping an eye on your credit will also help you identify any errors that show up on your credit report. These errors can sometimes damage your credit score and make it hard to qualify for a loan, so the sooner you identify and correct mistakes, the better.

Pay down your debt

One of the best things you can do to improve your chances of qualifying for a loan is to pay down your existing debts. When it comes to improving your chances of getting a mortgage, reducing your balances does double duty by boosting your credit score and reducing your debt-to-income ratio.

Diversify and keep accounts open

Two lesser-known factors influencing your credit score are your credit mix and the age of your accounts.

Your credit mix refers to the different types of loans you have. The more types of credit you’ve interacted with, the better. Someone with a credit card, auto loan, and student loan has more experience than someone with just a credit card, making them more appealing to lenders.

The age of your accounts refers to not just how long you’ve had access to credit, but the average age of each of your accounts. The older your average account, the better it is for your score. For that reason, avoid closing credit cards if you don’t use them and they charge no fee, because they can boost your credit age.

Increase your credit limits and keep utilization low

Your credit utilization ratio is another factor that influences your credit score. This ratio compares your credit balances to your total credit limit. The lower the ratio, the better.

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 keeping this ratio below 30%.

To keep the ratio low, try to boost the limits on your credit cards and avoid carrying large balances.

Build your application before reapplying

If your loan application gets denied, it’s okay to be disappointed, but there are things you can do to improve your chances of approval next time.

Unless the denial was for something basic like some missing information on the application, you should recognize that you’ll need to take multiple steps before you apply again, so don’t rush the process. Take the time to think about the explanations the lender provided for your denial, and develop a plan to improve your credit. Then, execute that plan and be patient. Whether it takes a few months or a year, you’ll see your credit and your odds of qualifying for a mortgage improve.

The bottom line: Don’t worry about past denials

You might worry that your mortgage denial will leave a trail if you try again. The good news is that while your credit report will reflect that you applied, it doesn’t show that you were denied.

It will mildly impact your credit as it will show as a hard pull, meaning that others will see that you applied for credit, but servicers understand that can happen when you’re shopping around. So again, being denied a mortgage shouldn’t impact your credit significantly.

If you’re ready to set out on the journey to buying a house, start your mortgage application online with the Home Loan Experts at Rocket Mortgage^®.