If you were rejected for a mortgage to purchase a new home or refinance your current one, you are not the only one facing this situation.
This is a widespread occurrence, particularly with larger lenders and banks tend to have less experienced loan officers who may make errors in loan qualification due to their lack of experience and knowledge. They often struggle to foresee obstacles to loan approval and to find solutions, resulting in difficulties in communicating effectively. These loan officers operate within a system akin to a "too many cooks in the kitchen" assembly line, where they handle only the loan application stage while several other colleagues navigate the intricate loan process. Consequently, this assembly line approach leads to fragmented communication, misplaced documents, and clients having to repeatedly explain their inquiries to different individuals in the process.
It is a sad reality that when bank and big lender loan officers acquire the experience and knowledge needed to excel in the business, they often become frustrated with their roles.
They leave this "loan factory" due to a lack of control and seek out more lucrative opportunities where they can have a greater impact on the loan's result.
Individuals who have been rejected by banks and major lenders should consider seeking out an experienced loan officer who is willing to invest the time to comprehend and address the reasons behind their loan denial.
The first step is to figure out why you were turned down. I'll list the most common denial reasons below.
Capacity -- debt-to-income ratio (DTI) or employment related reasons (by far the most common loan denial reason)
Collateral (property characteristics or value)
Capital - Insufficient cash (for down payment or closing costs)
Debt to income ratio (DTI) or Capacity
DTI represents the percentage of verifiable, eligible monthly income that a lender considers in the underwriting process in relation to a home buyer's monthly debts. These debts encompass the sum of minimum monthly payments indicated on the credit report or monthly billing statements, in addition to the total new mortgage payment (PITIA) - comprising principal & interest, monthly property taxes, monthly home insurance, and, where applicable, HOA monthly fees. Most loan programs feature 2 DTIs, with the exception of VA loans, where there is a lower ratio for housing expenses and an overall DTI that incorporates both the housing ratio and other outstanding credit debts.
One of the common errors made by some loan officers is failing to consider specific credit obligations, such as deferred student loans (which are still relevant), as well as familial responsibilities like child support or alimony, particularly if they are not documented on the credit report. Sometimes, there might be a recurring deduction on the borrower's bank statements for additional credit obligations that are not reflected in the credit report, like an IRS tax payment plan. Overlooking any of these aspects could pose a challenge.
The primary reason why many loan officers make mistakes is due to inaccurately calculating monthly qualifying income, which leads to an underwriter having to make corrections and reduce the amount initially approved by the loan officer weeks later. The correct calculation of lender usable income is so intricate that even seasoned loan officers often err. Consequently, these errors can result in the underwriter decreasing the income, causing a home buyer with a debt-to-income ratio right at the program limit to exceed it, jeopardizing the loan approval.
DTI limits differ depending on the loan program, but here are some general concepts regarding the maximum limit. Generally, a higher credit score and a larger down payment from the buyer can lead to higher DTIs during the automated underwriting process (AUS).
Conventional --housing 40% and overall 50%. The less risk to a lender in a transaction, the higher the allowed DTIs will be.
FHA--more lenient --housing DTI into the low 40's and overall as high as 55% or above. Many lenders will cap DTI at 50% and some at 55%.
VA --has one ratio --even above 50%, however some lenders will cap the DTI on VA.
USDA -- the most restrictive of the loan programs. Housing DTI 35% with overall DTI 45%. Marginally qualified buyers with lower credit scores will struggle to obtain loan approval at these max DTIs.
Credit history
While credit score is crucial, it's important to also consider other factors alongside credit scores.
Credit scores are issued by the three major credit bureaus: Experian, Equifax, and TransUnion. These scores may differ because not all creditors report to all bureaus, and some creditors report less frequently, resulting in variations in the data held by each bureau. Lenders typically consider the middle score of the loan applicant with the lowest score or the lower score if two scores are being used. A higher credit score increases the likelihood of loan approval and acceptance of higher debt-to-income ratios. Moreover, higher credit scores result in better loan terms, a topic that will be covered in a future article.
Mistakes that loan officers can make but underwriters later catch include misinterpreting the credit report and the AUS findings, as well as missing derogatory credit events such as bankruptcy, past foreclosure, pre-foreclosure, deed in lieu, judgments, and tax liens that may not always be reflected in credit reports. These discrepancies can come to light when underwriters conduct a thorough examination of an applicant's complete financial history. Underwriters have access to more detailed reports beyond the credit report, such as Fraud Guard or Lexis Nexis, which can uncover some of these negative items. An experienced and vigilant loan officer may detect signs during the loan application process and pose relevant questions that could expose these issues—and potentially identify solutions to ensure the loan approval proceeds smoothly.
Collateral (property characteristics or value)
Understanding the property type, value, and comps is crucial to avoid complications caused by a low appraised value in transactions. Experience helps loan officers identify overvalued homes or properties with unique characteristics that pose challenges during the appraisal process. Different loan programs have specific guidelines for various property types such as condos, manufactured homes, and properties with commercial or farming activities. Familiarity with these rules and adept navigation of each loan program are essential for achieving a successful closing.
Another aspect to consider is the occupancy status of the buyer. For instance, purchasing a second/vacation home just a short distance from the buyer's current primary residence can pose challenges in the underwriting process. Acquiring a new primary residence while retaining the current home for rental purposes or future sale entails adhering to specific rules for each loan program to ensure success. Lender underwriters are vigilant for any indications that buyers may misrepresent their actual intentions regarding occupancy, and seasoned loan officers will engage in discussions with buyers and their agents if any concerns arise regarding occupancy. It is preferable to address these issues promptly rather than encountering complications during the underwriting phase later on.
Capital (funds for down payment and closing costs)
Ensuring that a home buyer and their agent receive precise figures for all required buyer funds is essential. Underestimating the necessary funds is a frequent occurrence.
It is a problem when loan officers who lack experience or are lazy make mistakes. There is nothing more troublesome than a buyer not having sufficient funds to close the deal.
Another common mistake made by loan officers is failing to review a buyer's bank statements for recent unusual deposits. It is crucial to document all buyer funds coming from an approved source, which is typically straightforward during the application process but can become more challenging and time-consuming as the closing date approaches.
Gifts from approved sources are a regular occurrence in home transactions, but the process of documenting the source and transfer of funds varies slightly depending on the loan program. Failing to do so promptly can lead to delays and complications during the underwriting process.
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