You cleaned up your credit history, saved a large down payment and applied for a mortgage. Now your lender has given you that coveted preapproval letter, and you’re ready to shop the real estate market. That’s great news!
But home buyers must be aware that it’s possible to have a mortgage application denied even if you’ve been preapproved.
Whether you’re dealing with a denied home loan after preapproval or worried about the status of your mortgage application, it’s important to get the facts. Use the following guide to recover from the denial and improve your credit history before trying again.
Can a Mortgage Be Denied After Preapproval?
Yes, it’s possible to have your loan application denied after getting preapproved for a mortgage. It doesn’t seem fair, but the reason this is possible is because your loan has to go through the underwriting process before it’s finalized.
During this process, the lender goes over your finances with a fine-tooth comb to determine if they should approve you for a loan. If your financial situation has changed since you received a preapproval letter, your mortgage lender may deny your application.
What Are the Top Reasons a Mortgage Is Denied After Preapproval?
Job changes, appraisal issues and negative changes to your credit report are some of the most common reasons for a mortgage to be denied after preapproval. You may not get that final mortgage approval if an underwriter uncovers any issues. Let’s look at some specifics.
Negative item on credit report
If a negative item appears on your credit report between the time you receive a preapproval and the time you enter the underwriting process, your application may be denied. Any new negative items will make underwriters worry that you’re not a good lending risk.
Bankruptcies, tax liens, charge-offs, missed payments and new collection accounts are all examples of negative items that can reduce your credit score and result in a denial, even if you’ve already been preapproved.
You don’t need a perfect credit score to get a home loan, but you do need to meet your lender’s requirements regarding minimum scores. The minimum score varies with lenders, but a mortgage lender will usually want to see a credit score of 620 or higher.
Increase in debt
When you apply for a loan, the underwriter checks your debt-to-income (DTI) ratio, or the amount of debt you have compared to the amount of income you have. The lower your DTI, the more likely you are to make on-time payments to a mortgage company.
If your DTI is close to the lender’s limit (usually 36%) when you apply for preapproval, avoid adding new debt to your credit profile. Doing so can put you over the maximum and cause an underwriter to deny your application. To understand how this can happen, let’s look at an example.
Assume you earn $72,000 per year and have $25,200 in debt payments annually. If you apply for preapproval with a mortgage lender that has a 36% DTI limit, your DTI would be 35% – just below the maximum. Increasing your debt by $1,500 would increase your DTI to 37.1%, which would be over your lender’s limit.
Since income is included in your DTI calculation, any change in income can also affect your eligibility for a home loan.
In the previous example, you were making $72,000 per year and carrying $25,200 in debt, making your DTI 35%. If your debt stayed the same and your income decreased to $69,000, your new DTI would be 36.5%. You’d be over the limit for any lender with a maximum DTI of 36%.
Before you purchase a home, you need to have the home appraised, which is an independent assessment of how much the property is worth. Your lender requires this step to ensure that the home is valuable enough to serve as collateral for the loan.
Most mortgage lenders won’t approve a loan for more than the home’s value, so appraisal issues can lead to mortgage loan denial even if you’ve already been preapproved. For example, if you want to borrow $150,000 and the appraisal indicates the home is only worth $140,000, your application may be denied.
Appraisal issues are frustrating for both the buyer and the seller. Fortunately, there are some things you can do after a low appraisal.
For lenders, a sudden job change is a major red flag. It could indicate a change in income or a change in reliable income. This is especially true if you switch from a salaried job to an hourly job. Your lender may be even more concerned if you move to a commission-based position with unpredictable paychecks.
Although job changes are concerning to mortgage lenders, they’re not grounds for automatic disqualification. If you get a job with a higher salary, for example, a job change may help you reduce your DTI and make you a more attractive applicant.
It’s also a good idea to stay in the same field, if possible, to demonstrate that your job situation is stable. Moving from a help desk position to a systems administrator position is fine. But quitting the IT field to try your hand at dog grooming is likely to raise a few eyebrows.
Unexplained large cash deposits
Your lender verifies all sources of income and makes sure all your debt is listed on your credit reports. For this reason, it’s important to avoid unexplained large cash deposits during the underwriting process.
If you deposit thousands of dollars in your bank account with no documentation to explain where it came from, the lender is going to wonder if you didn’t report all your income or took out a loan after you received your preapproval letter.
It’s easiest to avoid large cash deposits completely. But sometimes borrowers receive a cash gift and need to deposit the funds in their bank account. In that case, gather as much documentation as possible, such as a letter from the gift giver stating the cash was a gift and doesn’t need to be repaid. (FYI, if you receive a large monetary gift, you will want to pay attention to the relevant tax laws.)
Changed loan requirements or lender guidelines
Even if you do everything right, the lender’s final mortgage approval requirements may change sometime between when you receive the preapproval and when the underwriter decides if your application should be approved. If you don’t meet the new guidelines, you won’t get the mortgage approval with that lender.
What Can You Do To Avoid Mortgage Denial?
You can’t eliminate the risk of loan denial, but you can be proactive about avoiding it. We’ve put together a list of do’s and don’ts to reduce the risk as much as possible.
- Open new credit cards
- Switch to a job that pays less than your old job
- Apply for auto loans or personal loans
- Make large cash deposits that can’t be verified
- Miss monthly payments on your existing credit accounts
- Continue making on-time payments
- Comply with your lender’s requests for additional information
- Keep saving money for closing costs and other related expenses
- Check your credit report regularly
What Can You Do If Your Mortgage Is Denied?
Although it’s disappointing, a mortgage denial isn’t the end of the world. You can do several things to improve your financial situation and get approval for a home loan in the near future.
Talk to your lender
Your first step should be to ask why your application was denied. If it’s because of something like a drop in credit score or a negative item on your credit report, you’ll have the information you need to increase your chances of approval the next time.
Although most lenders follow the law and treat all applicants equally, a few unscrupulous ones may deny mortgage applications for reasons prohibited by law. The Equal Credit Opportunity Act prohibits lenders from denying you based on your color, race, sex, religion, age, national origin or marital status. It’s also illegal to deny an applicant because they receive public assistance. If you believe that you were unjustly denied approval, you can file a report with the Department of Justice.
Dispute errors on credit report
Around 20% of consumers have an error on at least one of their credit reports. One of these errors could be hurting your chances of qualifying for a home loan. To improve your credit profile, check your credit reports and dispute any entries that aren’t accurate.
You may find the following types of inaccuracies:
- On-time payments marked as late
- Paid-off accounts showing a balance due
- Inaccurate account balances
- Accounts that don’t belong to you
- Public records that aren’t yours
Establish or rebuild your credit
If you’re a first-time home buyer, take time to establish your credit. You may need to open a secured credit card or an unsecured card with a low limit. Use this opportunity to establish a history of on-time payments. This can help you increase your score enough to qualify for a mortgage.
If your financial road has been a little bumpy, don’t panic. It’s possible to rebuild your credit history over time. You’ll want to make all monthly payments on time, avoid borrowing more than you can afford to repay and maintain a manageable number of credit accounts.
Establishing or rebuilding credit takes time, but remember that slow and steady wins the race. Improving your financial health can help you reach a favorable credit score to buy a house. It can also make it easier to save for a down payment and make monthly payments once you have that loan approval.
Lower your DTI
As a reminder, your DTI compares the amount of debt you have with the amount of income you have. If you’re denied after preapproval, take some time to work on increasing your DTI. You can do this by paying off debt or increasing your income or (ideally) both.
Build your application before reapplying
Before you jump into applying for a mortgage again, take the time to understand why your application was denied in the first place. Use feedback from the lender to improve your applicant profile before you get another preapproval.
If you recently switched jobs, for example, the lender may advise you to wait until you’ve been at the new job for a year before you submit a new application. You might want to apply for a lower loan amount or ask your lender about a loan program like those that help people get a Federal Housing Administration (FHA) loan or Department of Veterans Affairs (VA) loan.
Don’t Let Denial Get You Down
Nobody likes rejection, but having your application denied won’t ruin your chances to own real estate. Just because you’re denied once doesn’t mean you’ll never qualify for a home loan. With a little work and some good financial habits, you can build up your application, get that mortgage approval and buy the home of your dreams.