Getting preapproved for a mortgage is the first step toward buying a house. But what if your preapproval is denied? Though it can be disappointing, it doesn’t necessarily mean your homebuying dreams have been dashed forever. Here’s what might have happened and how you can improve your chances of gaining approval in the future.
What Is Mortgage Preapproval?
A mortgage preapproval is a letter from a lender that states you’ll likely qualify for a mortgage loan based on the financial details you’ve provided. The letter will also include how much money you could be approved for.
The preapproval process looks different for every lender. Some may request only some basic details like your name, yearly income, and estimated credit score, while others may ask for a credit check and full documentation of your finances.
A preapproval is not the same as a mortgage approval; it’s not a funding guarantee. Preapproval letters are designed to help you in the homebuying process, giving you a budget to work with, and showing sellers that you’re a good candidate for financing.
Why Do Lenders Deny Preapprovals?
Lenders deny applicants for a number of reasons, but it all boils down to how risky you are as a borrower. According to the Consumer Financial Protection Bureau’s (CFPB) analysis of 2019 mortgage-application denials, high debt-to-income (DTI) ratios were the culprit in around a third of denied mortgage applications. Poor credit history and collateral (the property being purchased) were the next two most common reasons for denials. Overall, lenders turned down 8.9% of mortgage applicants in 2019.
The Home Mortgage Disclosure Act requires lenders to report why they turn down mortgage applications, but it does not require the same reporting for denied preapprovals. Though mortgage-application denials are not the same as preapproval denials, understanding why lenders reject mortgage applications can help you know what they’re looking for from prospective homebuyers.
Here’s a look at some of the factors that may have played a role in your denial:
Your Debt-to-Income Ratio Is Too High
Your DTI reflects how much of your monthly income your debts take up, including things like student loan payments, credit card bills, and your expected future mortgage payment. Of the denied applications around 30% were due to DTI, according to the CFPB’s analysis.
Most lenders like to see a DTI of 43% or lower.
Your Credit History Isn’t Good Enough
Your credit history could have played a role, too. In evaluating your credit history, lenders generally look at your payment habits, how much of your credit limit you’re using, and the number of credit cards and loans you have. Late payments, accounts in collection, and a high number of debts could all factor into your denial. Around 19% of denied applications in 2019 were due to poor credit history, according to the CFPB.
Bad Collateral/Low Home Value
Your home is collateral for your mortgage. If you fail to repay your loan, the lender can foreclose on the house and sell it to make up for their losses. Sometimes, if the house isn’t valuable enough—particularly in relation to how much you’re asking to borrow for it—the lender might deny your application. Insufficient collateral was the reason for about 14% of all 2019 purchase application denials, according to the CFPB.
Mortgage lenders have been tightening their lending standards because of the coronavirus pandemic. Some have increased their credit score and down payment requirements, while others have lowered their debt-to-income ratio requirements. Because of this, it may be harder to get a preapproval in the current environment.
What to Do If You’re Denied
If your lender denies your application for preapproval, ask why. Getting an explanation for your denial can help you identify the issue (high DTI, low credit scores, etc.) and come up with a plan to resolve the issue:
- Improve your credit score: You can do this by paying down the balances on your credit cards, settling any accounts in collections, get caught up on overdue payments, and informing credit bureaus of any errors found on your credit report.
- Be consistent: Pay your bills on time, every time, and make sure you have steady employment. These can both help your chances of approval.
- Pay down your debts: The more you’re able to reduce your debts, the lower your DTI will be. Aim to get your DTI under 43%.
- Find an additional source of income: Increasing your income can also reduce your DTI. Consider taking on a side gig or asking for a raise but know that lenders typically take your past two years of income into account when assessing your ability to repay your mortgage.
Applying with several lenders can also help. Qualifying requirements vary by lender—particularly during the COVID-19 pandemic—so shopping around can give you the best shot at getting approved.
The Bottom Line
Having your preapproval application denied doesn’t mean the end of your homebuying journey. Find out exactly why you were denied, take steps to remedy the issues, and make sure to pull your credit report often to evaluate how you’re doing. You can also work with a credit or housing counselor. They can point you toward the best steps for your unique situation and credit.