Being denied a mortgage loan can seem to shatter your dreams of home ownership. But arming yourself with knowledge before sitting down with a lender can improve your chances of being approved. Here are three of the most common reasons mortgage applications get denied and how you can avoid them:
1. Poor Credit History. Not surprisingly, a poor credit score or too many negative marks on your credit report are major reasons prospective home buyers are turned down for a mortgage.
Before you sit down with a lender, carefully review your credit reports from all three bureaus. Errors are common. If you find something that’s incorrect, follow the bureau’s process for requesting a correction. If the negative items are accurate, take some steps to improve the situation before applying for a mortgage.
Try to pay down any credit cards so they are no more than 15 percent of your credit limit. If your history shows some late payments of 30 days or less, contact the creditor. They may remove the mark for you. If you dispute a late payment through the credit bureaus, the creditor has 30 days to validate the record or it has to be removed from your report.
Sometimes, the only way to fix your credit is to let time heal your credit history. Pay your bills on time and don’t overuse credit while waiting for older items to drop off your report.
2. Debt-to-Income Ratio is too high. Mortgage lenders will calculate your debt-to-income ratio when qualifying you. Add together all your monthly debt payments and your anticipated mortgage payment. Divide this sum by your monthly gross income. Multiply the resulting number by 100 to get a percentage.
Lenders typically allow a maximum of 43 percent to qualify for a mortgage, though they would rather see the ratio at 36 percent or lower. They also want no more than 28 percent of your monthly income to go toward your expected mortgage payment.
Pay off personal loans, consider refinancing auto loans and pay down credit card debt if your ratios are too high. Be sure all income is verifiable.
3. Inconsistent Employment or Unverifiable Income. The lender is going to want to know you have a steady income and can pay back the mortgage.
Lenders prefer to see two years of consistent employment. If you’ve got long gaps between jobs and did a lot of job hopping, you could be denied a mortgage. If self-employed, you will be asked to show at least two years of income tax records to verify your income. Lenders are going to look at your adjusted income. Be careful about taking a lot of business deductions at tax time to reduce your taxable income. It will hurt you when you apply for a mortgage.
Avoid gaps in employment and be sure your income is verifiable. If you have a spotty job history, this is another instance where you may need to let time heal your record.
Sit down with a lender and ask what steps they recommend you take before applying for a mortgage if you are concerned about being approved. Their insight can be extremely useful. Some mortgage lenders may have programs to help you clean up your credit or refer you to a credit counselor who can help you improve your credit.