If you’re buying a home and applying for a mortgage, you’re likely prepared for a ton of paperwork and back-and-forth communication with your mortgage lender. And like many homebuyers, you’ve taken steps to prepare financially (saving money for your down payment/closing costs and paying off credit cards). Your efforts are commendable. But even when you take such measures, a mortgage underwriter could reject your home loan application.
Credit issues and/or a lack of assets aren’t the only reasons why mortgage lenders turn down applicants. To avoid any surprises or disappointments once you’re set to purchase a home, it’s important to educate yourself on surprising reasons for a mortgage rejection.
If you’ve recently graduated from college or recently returned to the workforce after an extended break, you might be eager to purchase a home. But even if you’re gainfully employed and making money, acquiring a mortgage is tough when you haven’t been employed for at least 24 consecutive months.
Stable employment is how lenders assess whether your income is dependable, which is essential to be deemed an ideal candidate for a mortgage. Most lenders prefer at least two continuous years of work experience with no employment gaps or career hopping. Unfortunately, some lenders reject applicants who don’t fit these parameters.
Tax write-offs minimize your taxable income and slash your tax bill at the end of the year. But if you’re a self-employed borrower writing off business expenses, or if you’re an employee who’s eligible to claim non-reimbursed business expenses (such as business mileage and business meals), too many business tax deductions can reduce your net income considerably. The consequence can be qualifying for a low mortgage amount, or worse, not qualifying for a mortgage.
Mortgage lenders can only approve your loan application if your tax returns show sufficient income. The good news is that lenders can potentially add back some tax deductions to your income to help you qualify. Even so, if you’re planning to purchase a home, plan ahead and limit your number of tax write-offs for at least two years prior to the purchase.
Co-signing a loan for someone else could also trigger a mortgage rejection. Although you might never make a monthly payment on this loan, your name and Social Security number are attached to the loan, so you’re equally liable for the debt. If the primary signer defaults, you are obligated to take over the payments. Therefore, your mortgage lender takes this debt into account when calculating your debt-to-income (DTI) ratio, which is the percentage of your monthly debt payments in comparison to your income. If the monthly payment on a cosigned debt raises your DTI ratio above an acceptable amount, you might not qualify for a mortgage. As a general rule, total monthly debt payments including the home loan should not exceed 36% to 43% of your gross monthly income.
If you’re rejected for a mortgage on this basis, you’ll have to postpone your home purchase until the primary signer pays off this debt, or the primary signer can refinance the debt and remove your name from the loan. Understand, however, refinancing only works if the primary signer has the credit score and income to qualify for a replacement loan on his own.
If you’re thinking about buying a property in a community with an HOA fee, a lender may reject your mortgage if these fees push your total housing expense (principal, interest, taxes, insurance and homeowner’s association fees) above 28% to 31% of your gross monthly income.
There are exceptions, however. Your lender may allow you to borrow more than this recommended limit, but only if you have compensating factors such as an exceptionally high credit score or a sizable cash reserve “after” paying mortgage-related expenses.
Just because a home seller accepts your purchase offer doesn’t mean the sale is guaranteed. Regarding the purchase of a property, everything on your end might align. However, the lender will order a property appraisal to determine the home’s value. In a purchase situation, the lender will not approve a mortgage for more than a property’s appraised value. So if the home appraises for less than the agreed-upon sale price, the lender will reject the mortgage unless you can renegotiate the price with the seller.
The seller will likely reduce the price to proceed with the sale. But if the seller can’t budge on the price—maybe because they owe more than the home’s worth—you’ll need to pay the difference out-of-pocket or walk away from the transaction.
