I can't get a mortgage approval: your rescue guide

For the vast majority of people, buying a home means getting a mortgage. Most buyers go through pre-qualification first, which provides them with a working budget if the mortgage is successful.

While this can be a great way to determine the size of the loan you're likely to get, it offers no guarantee of mortgage approval down the track. Would-be buyers are occasionally given a nasty surprise when they try to get mortgage approval, with denial sometimes setting people back for months or even years.  

Getting knocked back for a mortgage can seem like a soul-crushing experience, but it doesn't have to be the end of the world. Having a mortgage application denied doesn't mean you can't get a mortgage. It simply means you have to make some changes.

There are many reasons why a loan request can be rejected, some of which are relatively easy to fix. You will have to do some work, so it's important to be proactive and find out why you were denied before moving forward.

So you got denied, now what?

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You can be denied a mortgage for many reasons, some of which are easy to fix and others which may be beyond your control. While lenders look at the relationship between your income and debt levels compared to the mortgage amount, your credit history also plays a fundamental role.

Even though a rejected loan application shouldn’t be a surprise if your loan officer has given you an accurate assessment, the application process can be rigorous and fail at any stage.

Whether you're asking for too much, not earning enough income, or living with a bad credit score, banks and other lenders are supposed to provide you with the reasons why you were denied. This should provide you with enough clues to move forward and make the changes that are required.

While mortgage denial can come down to things such as new loan or paperwork requirements, your circumstances can also play a crucial role. Before you can make the changes necessary to get approval, it's important to understand how the mortgage application process works.  

How the mortgage application process works

While shopping for a new home can be lots of fun, getting a mortgage can be a nightmare if you don't know what you're doing. Unless you understand this process, you're always going to feel left behind.

Pre-qualification vs pre-approval

It's crucial to understand the difference between mortgage pre-qualification and mortgage pre-approval. Even though they sound similar, pre-approval is much harder to obtain and gives you much more security going forward. Pre-qualification is only the first step of the mortgage approval process, with far too many people relying on it as a form of financial security.

When you apply for pre-qualification, you provide the lender with information about your income, liabilities, and assets. Based on the information provided, the bank will estimate roughly how much money they are willing to lend you.

While important, this entire process is informal and can even be conducted on the phone. While the pre-qualified loan amount is not guaranteed, it may come with a guaranteed interest rate in writing for a specified period.    

In contrast, mortgage pre-approval is the approval and confirmation of a specific loan amount. While you can get pre-qualified for a mortgage without anyone checking your credit history, pre-approval always involves a detailed and often highly meticulous analysis of your credit score, current employment, employment history, and documentation.

Final loan approval only happens after an appraisal has been completed, with the loan amount always applied to a particular property. Mortgage approval is dependent on the five following factors:

1. Income

Above all else, the bank wants to know if you're capable of paying back the loan without exposing them to risk. The level of income required depends on the size of the loan and the length of the loan period. While a healthy deposit will always help, banks and other lenders need proof of income to lower their risk and improve your chances of approval.

"No documentation" loans are a thing of the past, with all borrowers expected to have recent pay stubs that show ongoing and year-to-date income, tax returns for at least two or three years, quarterly statements for all existing bank accounts, and W-2 employee statements for the last two years.  

2. Assets

The things that you already own are of great interest to banks and other lenders. Whether it's other houses, cars, bank accounts, or your stock market portfolio, lenders will always require proof of assets before they approve a mortgage.

You will need to provide present bank statements and investment account statements to prove that you have enough for a down payment, with banks also likely to look at non-liquid assets such as cars and other houses in case of default or possible foreclosure.

3. Liabilities

The money you owe other people is also a great concern to lenders, with your income and assets only able to be measured accurately when they are compared with your outstanding debt. From existing mortgages and car payment plans through to store credit cards, the bank will only approve a mortgage when your income is at a level much higher than your outgoing debts.

A 43% debt-to-income ratio or better is typically required. If you have received money from a friend or family member to assist with the down payment, you will need a gift letter to prove that this is not a loan.

4. Credit history

This is one area where so many people fail when it comes to mortgage approval. Having a good credit history is the basis of every successful loan application, with most lenders in the United States reserving the lowest interest rates for customers with a credit score of 740 or above.

Most banks require a credit score of 620 or above to approve an FHA loan with a 3.5% down payment. People with a credit score below 580 will always be required to make a larger down payment of 10%, with a score any lower than that unlikely to be accepted at all.

There are many ways you can improve your credit score or work with lenders to set more realistic goals. The situation in Canada is similar, with credit scores generally ranging from 300 to 900.

5. Employment and documentation

While lenders will always analyze income levels using tax records, pay stubs, and other cold hard facts, they are also likely to make decisions based on more subjective data. For example, the bank is likely to call your employers to verify your employment status, with some lenders even calling past employers to make sure everything is accounted for.

Along with your income, the length of time you have been employed is a crucial consideration. Self-employed borrowers generally have much bigger hurdles to overcome, with the additional paperwork needed to prove business profit and income.

Other than your employment records, lenders are also likely to ask for your passport, your driver’s license, your Social Security number, and your signature so they can access your credit records.  

Five common reasons for getting a mortgage denied

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1. Bad credit score

Your credit score plays a huge role in determining the loan type and amount that you’re eligible for, along with the interest rate you're likely to receive. Understanding your credit score and how it relates to your credit history is one of the best things you can do to improve your chances of mortgage approval.

People going for a home loan are often wrong about or completely unaware of their credit score, with different credit bureaus using different ways to measure financial health. With three credit bureaus, the lender will often use the middle score as a measure of risk. This kind of vertical disparity between credit monitoring companies can also occur on a horizontal or temporal basis, with credit scores often changing significantly throughout the month.  

2. Gaps in employment

Gaps in employment history indicate poor long-term stability, which is one of the biggest reasons mortgages are denied. Above all else, continuous employment shows the lender that you’re a better credit risk.

In some ways, the stability of your employment plays an even more important role than the level of your income, after all, banks are normally more than happy to extend a loan if the interest keeps coming in.

People without a lengthy history of working in the same field could face roadblocks, with self-employed people and those working multiple part-time jobs normally needing extra documentation and assurances.

It's also important to note, that if you've changed careers in-between mortgage pre-qualification and pre-approval, the lender may not consider your new job to be adequate for the loan.   

3. Unsustainable debt levels

You will face difficulties getting mortgage approval if you're living beyond your means. Along with income and assets, the banks will take a good hard look at your liabilities and how they relate to your employment income.

From credit card bills and car payments through to student loans and existing mortgages, unsustainable debt levels will always raise eyebrows among lenders.

The new qualified mortgage rules just issued by the Consumer Financial Protection Bureau sees buyers needing a 43% debt-to-income ratio, with the ideal ratio for aspiring homeowners being 36% or lower. If you don’t fit that profile, there are ways to overcome that number. Paying down your debt is a great way to improve your credit score and enhance your chances of approval.

If you've received pre-qualification for a mortgage but had an approval denied, it maybe because you've taken on additional debt. Even small changes in your debt levels can wipe out your pre-approval status.

4. Problems with the property

When you get denied for a mortgage, it's not always your fault. Sometimes the value of a property is simply not enough to guarantee the amount of the mortgage loan being applied for. A low-ball appraisal can often complicate a mortgage application and lead to a denial of the loan.

Banks and other lenders also have their own rules in place regarding property valuations and locations, with the bank likely to pull out at the last minute if they discover something about a property that they don’t like. For example, some lenders won't approve mortgages for properties close to gas stations, airports, or anything else they may make resale a risky proposition in the case of foreclosure.   

5. Not enough cash

Not having enough cash for a down payment is one of the biggest reasons why so many mortgage applications fail. While it was once possible to get a home loan with no deposit whatsoever, things like "no deposit" and "no documentation" loans are very much a thing of the past. These days, you'll need at least 3.5% plus closing costs, which can account for 3% of the purchase price themselves.

This figure is likely to be much higher if borrowers have a credit score below 580, with a 10% or even 20% deposit required in some situations. Putting 20% down allows you to avoid private mortgage insurance (PMI), which can be added to the mortgage interest rate like an insurance policy. If you simply don't have the money for a deposit, gift money from blood relatives is often a possibility.

Five ways to improve your credit score

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1. Make sure your credit reports are accurate

To improve your credit score, you first need to examine your credit history and make sure that the information collected is accurate. Everyone has three credit reports in the United States, one from each of the three major credit bureaus: Experian, Equifax and TransUnion.

In contrast, there are just two major credit bureaus used in Canada: Equifax and TransUnion. While it's easy to think that big names such as these never make mistakes, a 2012 report from the Federal Trade Commission found that 1 in 5 consumers had an error.  

Under the Fair Credit Reporting Act, you’re entitled to a free copy of all three reports once a year, which makes it easy to have a look and see if there are any mistakes. The FICO credit score and other credits scores operate within the range of 300 to 850, with a range of 300 to 900 used in Canada. The following tiers are a good guide, with

  • Excellent Credit - 750+

  • Good Credit - 700-749

  • Fair Credit - 650-699

  • Poor Credit - 600-649

  • Bad Credit - below 600

2. Pay down your debt

It may sound simple, but paying down as much debt as possible is the best way to improve your credit score. To begin improving your score, you should aim to keep your credit card balances low and eliminate as much revolving credit as possible. While you should always aim to pay down your debt rather than moving it around, debt consolidation can prove useful in some situations.

Fixing up late payments and avoiding late payments in the future is central to this process, so don't forget to set up payment due date alerts and get yourself organized. Some credit card issuers will forgive late payments once or twice if you give them a call, especially if you have a long track record of making on-time payments.

You don't have to stress out if you're a few days late, however, with credit bureaus not marking payments as late until they're at least thirty days past the intended due date.

3. Increase your credit age

While you can't change your credit history, you can improve your credit age to some degree. Your credit age is the length of time that lenders use to work out your credit score, which is one of the reasons why it can be hard for young people to access credit.

It is possible to piggyback on a friend or family member’s credit card in some situations, but you'll only want to do this if they have a long history of on-time payments. If they add you as an authorized user, you can use their credit history to your advantage.

The other possibility is simply to be patient. Even a few years can make a big difference, with someone who has used credit successfully for a long time seen to be a lower risk. There are three primary ways the FICO scoring formula looks at your length of credit history:

  • Average account age

  • Oldest account

  • Newest account

4. Get a credit card

While it may seem counter-intuitive, getting a new credit card can be a great way to improve your credit score in some situations. Lenders want to make sure you can handle different types of credit before they lend you money, with different account mix formulas used to analyze and measure credit cards, mortgages, auto loans, student loans, and any other type of loan.

If the only credit you have is in the form of credit cards, you may be keeping your score from rising. Not having a history of paying down your credit card may also have a negative impact on your score.

Getting a secured credit card is a great option, with this type of credit card involving a deposit into a checking account that “secures” the line of credit the bank or lender is extending you.

For example, you can open a checking account with $200 in it and get a line of credit for the same $200. That way you have no risk of not making payments, but can still receive a good credit score due to your positive payment history.

5. Limit credit applications

Lots of people don't understand how the credit score works. Along with looking at your payment and default history, credit bureaus also analyze credit applications. While this impact is minimal, a hard inquiry can have a negative effect on your credit score.

Whether it's a car loan or a store credit card, a hard inquiry is created when your credit report is accessed and reviewed by a business. While there is a limit on how much these inquiries affect you, they can drop your credit score by as many as five or ten points, which can seriously affect your overall score and your chances of getting a mortgage.

Other ways to help yourself get approved

Your credit score plays a crucial role in mortgage approval, but it's certainly not the only factor to consider. If you've been denied a mortgage, there are many other ways to improve your chances of success. For starters, you can decrease the amount of the proposed loan by increasing your deposit or finding a cheaper property.

While this is not always ideal, it can be a great way to get onto the property ladder quicker. Once you have a mortgage and a few solid years of making payments, you can always start to climb up the ladder.

Shopping around can also be effective, with different loan providers offering different types of mortgages for different buyer profiles. For example, a bad credit score at a major bank may not be a problem down the road at a smaller credit union.

Changing your location can also improve your chances of success, with houses sometimes cheaper and lenders possibly less demanding in certain cities. Changing your employment can also help, especially if you stay within the same industry sector and gravitate from a casual position to a full-time position.

If you're in a single-income household, your partner may be able to get a full-time job for a few years to improve your chances of mortgage approval. The world of real estate investing is changing all the time, with new avenues opening up all the time.   

Your five-step mortgage approval action plan

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1. Get mortgage pre-qualification

While mortgage pre-qualification is not the same as pre-approval, it does give you a rough idea of how much money you have to play with. Meeting with a lender face-to-face will give you an understanding of what they're looking for, which will help you navigate the remainder of the process.

2. Increase your qualifying income

While this is easier said than done, the higher your income is, the more likely you are to be successful with a mortgage approval. Not all qualifying income is created equally, with long-term, full-time positions carrying much more weight than part-time jobs or casual self-employment.    

3. Pay off your debts

Reducing your debt is crucial before applying for a mortgage. From large debts such as car loans and student loans through to credit cards and store cards, your liabilities will always reduce your chances of approval. Pay off your highest interest rate debts first and don't apply for any new credit.

4. Improve your credit score

There are many ways to improve your credit score, most of which are listed above. The five major scoring factors used by credit bureaus are your payment history, your debt amount, the age of your accounts, the mix of accounts, and your history of credit applications.

5. Think outside the box

While getting rejected for a mortgage can be heart-breaking, all is not lost. You can get a second opinion from someone else in the same company, shop around with other financial institutions, and try to see your application through the eyes of lenders to improve your chances of success in the future.