Mortgage Application Declined? Here’s How to Respond

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Buying your first home (or a subsequent one) may fill you with excitement. Making the decision to become a homeowner is likely one that you have carefully considered. After possibly months of searching, you may have found the perfect home – one where lifelong dreams for stability, community belonging, and the start or growth of a family will be fulfilled.

You may think you have done everything right in getting ready for this big step. But then, your mortgage application is declined. Here are ways to respond.

Don’t panic! Here’s what to do if your mortgage is declined:

Talk to Your Mortgage Lender

If your mortgage loan request has been denied, ask why your lender rejected your application. You have a right to know “the specific reason for the rejection” according to the Federal Trade Commission (FTC).

You may learn that your ratios, such as your debt-to-income or loan-to-value ratios, were too high or your credit score too low. If you have done an independent evaluation of your numbers, then you can confirm whether the lender has cause for concern or if there has been a miscommunication.

Get your documents in order to discuss and tackle problems that led to the rejection.

If You Were Rejected Due to a High Front-End Ratio

Consider whether your proposed mortgage payment realistically fits within your means. Just as mortgage lenders often do, look at the percentage of your income devoted to your mortgage payment. Specifically, calculate your front-end ratio (monthly housing expenses divided by monthly income, expressed as a percentage) to determine if you could struggle to make payments. Ideally, this ratio will be 28% or less.

At first glance, your income may readily cover the principal plus interest associated with the mortgage loan. However, other expenses may be included in your mortgage payment, such as property taxes, homeowner’s insurance, and private mortgage insurance. Depending on the location of your home and the amount of your down payment, these numbers could dramatically increase your monthly payment, moving the affordability of a home from entirely possible to extremely difficult.

Identify ways to reduce your mortgage payment, particularly via add-ons that you may be able to control. For example, talk with your insurance agent about increasing your home’s security features to reduce the cost of your homeowner’s insurance.

If You Were Rejected Due to Debt Load From Other Loans

When evaluating your financial picture, look at your outstanding loan balances including credit card debt, student loans, and vehicle loans. Consider how much of your current monthly budget is applied to payments that service this debt.

Generally, your mortgage lender needs you to keep total loan payments (including your proposed mortgage payment) to 36% of your monthly income. This percentage is your back-end ratio (aka debt-to-income ratio) and is calculated by dividing total monthly debt expense by monthly income, expressed as a percentage.

Think about how and why you have acquired debt. Have you borrowed for your college education and a vehicle in order to build a career that generates significant income? Or have you spent carelessly and accumulated credit card debt? How have you managed your income to reduce your debt load?

If you make payments on time and are steadily reducing debt, then you may have no problem handling your current debt load plus a mortgage payment. But if you have struggled to keep up with payments and your credit card balances are growing, then you may need to take aggressive action to deal with your loans.

Measure your progress toward paying off non-mortgage debt. Develop a plan or simply stay focused on your current plan to reduce outstanding balances. Consider paying off one loan in order to eliminate a payment and reduce your back-end ratio.

If You Were Rejected Due to Your Credit Score

Consider that your creditworthiness may have prevented you from obtaining the mortgage you wanted. To deal with this issue, start by pulling your free credit reports at AnnualCreditReport.com. Make sure your information is correct and up-to-date.

In addition, you should be able to get your credit score from the mortgage lender that declined your credit application. Often, a lower credit score may simply mean higher mortgage costs, not a flat-out rejection. However, a higher interest rate may have priced the mortgage payment out of your reach.

Based on your credit information, identify methods of potentially improving your score, such as eliminating credit card balances.

If You Were Rejected Due to the House Value

You may have fallen in love with a house and decided to buy the property at nearly any price. But since your mortgage application was denied, contemplate whether your offer (and loan request) may have been out of sync with the home’s market value.

The lender’s rejection of your mortgage application may have had nothing to do with your financial worthiness and readiness, and everything to do with the value of the home. No matter how great your ability to repay a loan, lenders must protect themselves by making sure that the loan collateral (your home) has a certain financial value. As a result, lenders may require a certain loan-to-value (LTV) ratio.

If your real-estate deal falls through because the home is valued at substantially less than your offer (and loan request), consider making a counteroffer or verifying the accuracy of the appraisal. Or make a larger down payment in order to reduce the LTV to a level acceptable by your lender.