The home loan process is one of the most involved and complicated processes out there. And it’s no surprise: Buying a home is a major financial commitment, and a lender puts up the money and takes on the risk.
Even though we often talk in terms of “ownership” when it comes to buying a house, the reality is that the lender fronts the money. The lender puts down the money, and you repay the lender (with interest) over time. The initial risk of the purchase is taken on by the lender, and if you default, it’s the lender that has lost money.
Here are 5 reasons the lender might decide that you are an unacceptable risk, and turn you down:
1. Poor Credit
The biggest reason that you might be turned down for a mortgage is your poor credit. If you have a credit score below 650, your chances of getting a conventional loan are pretty slim. With a score below 620, you might not be able to qualify for a conventional loan at all.
You can qualify for a loan backed by the FHA if you have a score of 580, but once it falls below that point, you will have a difficult time qualifying for any mortgage. Before you apply, do what you can to get your credit score up.
2. Unstable Income
While your credit score is a big part of your application process, it’s not the only factor of importance. Your income matters as well. Even if you have a good-sized down payment, the lack of a stable income can mean rejection. You need to be able to show that you will be able to make mortgage payments regularly.
If you have a history of changing jobs frequently, or if you have long gaps in employment, you might have a hard time qualifying for a mortgage. Self-employed applicants might need to show a longer tax return history, or go through an income audit, in order to prove stable income.
3. Wrong Property
The type of property you plan to purchase matters. If you are buying a second home, or if you want to buy a rental property, your application will be scrutinized carefully to ensure that you can “afford” multiple payments. Additionally, some types of properties, like condos, have additional restrictions. It’s harder to get an FHA loan for a condo, even if it is a first mortgage, than it is for a stand-alone home.
You might also run into trouble if the appraisal on the home doesn’t come back showing what the lender would like to see. Take this into account before you apply.
4. Debt-to-Income Ratio
Some banks, since the financial crisis, have gone back to using a 28/36 qualifying ratio. In this measure, the lender looks at your loan payments and compares them to your monthly income. If your total loan payments — including your new mortgage payment — amount to more than 36% of your monthly income, your mortgage application might be rejected.
Even if a lender is more generous, allowing your loan payments to amount to up to 40% or 45% of your monthly income, you might still have difficulties. Lenders are wary of applicants who might struggle to meet their debt obligations each month, since it can increase the chance that you will default.
5. Small Down Payment
While some lenders are returning to the pre-2008 days of zero down payment loans, many still like to see a good-sized down payment. Many lenders require a down payment of 5% to 10% of the purchase price. If you plan to get a building loan, you might need a 20% down payment. Even the FHA requires a 3.5% down payment if you want to buy. Without a sufficient down payment, there is a chance that you’ll be turned down for a home loan.
Before you apply, check to see if any of these items are likely to raise red flags on your application, and take steps to remedy the problem.