Why do some mortgage applications get approved but others denied? These days, banks and underwriters are more discerning than ever, navigating a very fine line between a qualified borrower and another loan rejection on the scrap heap. Unfortunately, when other lenders don’t do their jobs correctly by setting up loan applications to succeed, borrowers become the collateral damage, many of them losing out on a great interest rate, saving money, or even the house they want to buy.
While we have a phenomenal loan approval rating because of the work and diligence that goes into every file ahead of time, it does happen more than you might think for others in the industry.
In fact, the Mortgage Bankers Association reports that lenders reject about 50% of all applications they receive to refinance a mortgage, and up to 30% of purchase loans are denied. One in two and one in three are pretty head scratching track records.
The number one reason for mortgage applications getting denied – for both purchases and refinances – was that the applicant’s credit history wasn’t sufficient, according to the data collected from the Home Mortgage Disclosure Act. Other common reasons for loan denials include too much debt, too little income, and too little money in the bank as reserves.
However, there is reason for optimism. Applying for a mortgage loan may seem like a complex and mysterious process, but in fact there are some fundamental elements that every underwriter and lender looks for before approving a borrower’s application. Not coincidentally, we examine these factors thoroughly when we first review an applicant’s file, and make sure everything is set up for a green light by the time we send a file in to the bank to start the underwriting process. So whether you’re shopping for the best rate on a refinance or applying for a mortgage on your first home purchase, it’s important to understand these 5 pillars of approval
- Ability or Income
The banks want to know, first and foremost, whether you’ll be able to comfortably repay the loan – on time and in full every month. And the biggest indicator of your ability to repay is your monthly income. But it’s not just about what your current pay stub shows; their calculations revolve around a calculation called Debt-to-Income Ratio. That ratio factors in not only what you make (and your gross – not your net) but also how much is going out every month, including the proposed new mortgage payment (with principal, interest, taxes, and insurance included,) as well as credit card and installment loan payments, student loans, alimony or child support, etc. If the ensuing ratio lies below their threshold for that loan program, they consider you a safe bet to repay the loan.
- Stability or Job History
While your current pay stub at your current job may look wonderful, lenders also want to gauge how stable that income will be. For instance, if you just started the job a couple months ago, that’s way more volatile than if you’ve worked there for over two years. And if you’re self-employed or at a job that pays commissions instead of a set salary, there is a huge chance you’ll have down months and not be able to pay your mortgage. Lenders value stability so they love loan candidates who have been at the same job, in the same career, and receiving steady paychecks as a W2’d employee for a good amount of time.
- Collateral and Money Down
Lenders also want to ensure that there is adequate collateral if they approve you for a loan. You thought collateral was only for installment loans? In fact, mortgage lenders look for sufficient collateral from a borrower in two forms. First, they want to make sure that the borrower has sufficient assets before approving the loan. During the loan process, underwriters will look for bank accounts, retirement accounts, stocks, investments, and even other homes that are paid off. All of this is evidence the borrower is solvent and has a nice financial pad or safety net in case of a job loss, divorce, or anything else that might threaten to derail them from paying their mortgage every month.
The second form of collateral is value in the house itself, above and beyond the amount of the loan. Lenders will always request a formal appraisal to make sure the house is worth what it should be in real life – not just on paper.
- Loan to Value Ratio
A ratio called Loan to Value is a huge consideration when a borrower applies for a loan. That references how much money the borrower is putting down if they are purchasing the home, or how much equity is in the property if it’s a refinance or home equity or second mortgage. Generally, the more the borrower puts down for the home, or the more it’s worth above the loan amount, the lower the risk for the bank. During the real estate boom, no-money down loans (and stated income loans) were approved like wild fire, basically negating the need for borrowers to put any “skin in the game.” After the subsequent real estate collapse and record wave of foreclosures, short sales, and defaults, the banks learned one important piece of knowledge: the biggest predictor for default on a mortgage isn’t a borrower’s credit score, or what kind of loan or interest rate they get, but how much money they put down. The more people invest out of their own pocket, the least likely they are to ever default.
- Credit score or FICO
Credit score, commonly called FICO score after the preeminent credit reporting agency, Fair Isaacs, is a significant factor when applying for a mortgage. Lenders carefully scrutinize a borrower’s credit report as a gauge for risk and evidence of past repayment of loans. If a borrower has a low credit score, or if they have a foreclosure, short sale, or bankruptcy on their report, it may automatically disqualify from getting another mortgage for a certain number of years. As a general rule, the higher the credit score, the more lending options the borrower has available to them and the better their interest rate will be.
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