I recently came across an article on Realtor.com which discussed the main reasons mortgage applications are rejected and the embarrassment an applicant goes through upon receiving that rejection.
Using four of the five reasons cited in the article, I want to discuss some applicant fears and obstacles you may encounter while processing and underwriting a mortgage application. We’ll also discuss actionable steps your potential borrowers can take to improve their chances of getting approved in the future and achieving their dream of homeownership.
Your Applicant Doesn’t Use Credit Cards Enough
One of the main reasons mortgage applicants’ applications are rejected is the ever-mysterious credit score. This is understandable given consumers tend to only have a cursory knowledge of credit.
In underwriting a mortgage to determine the borrower’s credit worthiness, you look at a tri-merge credit report which includes a credit score from each one of the bureaus. Not using credit cards enough or having too short of a credit history can hurt applicants because there’s no proof of being able to reliably repay debt obligations.
What to look out for: The classic credit score model used for Agency loans (Fannie Mae® and Freddie Mac®) may generate a score with as little as one trade line that has been open for at least six months and/or there has been credit activity within the last six months.
Both Fannie and Freddie’s Automated Underwriting Systems (AUS) may issue a positive recommendation for approval with the application even with only one score returned from the three credit bureaus. Based on changes to their systems, they can now issue positive recommendations for applicants with no traditional credit histories or scores.
What you can do to help your borrower: Because Fannie and Freddie now offer a way to analyze applicants with no traditional credit or non-traditional credit, you can pursue collecting the correct documentation to help your applicants apply with non-traditional credit. Please see Fannie Mae’s Desktop Underwriter Version 10.0 Overview and Freddie Mac’s Borrower’s With No Credit Scores for more information.
Your Applicant Recently Opened New Lines of Credit
When an applicant has opened new lines of credit shortly before applying for a mortgage, that is usually a red flag to lenders and processors. As a lender, you should be concerned by the indebtedness of the borrower and reviewing the amount of debt they are obligated to pay monthly vs. their gross monthly income.
The borrower’s debt-to-income ratio (DTI) is one of the most critical measurements in evaluating the file. Because DTI is such a heavily weighted factor in evaluating a borrower’s capacity to pay back the loan, it’s never a good idea for a consumer to take on additional debt right before making the largest financial transaction they’ll likely make in their life.
What to look out for: During your review process, you should investigate any inquiries on the credit report to determine if new credit has been issued.
Also, new credit and inquiries into new or existing credit limits impact a customer’s credit score. This category only accounts for 10% of the maximum credit score attainable whereas payment history (35%) and amounts owed (30%) are far more impactful in the calculation of a credit score.
You can learn more about credit scores on My FICO.com for additional information on how a score is calculated.
How to help borrowers: Should a borrower have their mortgage application rejected, encourage them to wait for another 8-12 months before applying again. During this time, they should not open any new lines of credit and instead focus on paying off any debt on existing credit lines.
Your Applicant Recently Changed Jobs
As part of the mortgage application process, you always need to capture a minimum of two years of work history on the application and validate the information based on your AUS results or your manual underwriting guidelines. You are responsible for looking into an applicant’s recent job change if it happened within the last two years.
To some, an applicant changing jobs can be ominous. That’s because there can be some question as to if their income is stable.
Here’s what a good applicant should look like if they’ve changed jobs recently:
- Base income remained the same or increased
- Receives regular and consistent payments
Applicants with these characteristics do not represent additional risk for repayment.
What to look out for: When evaluating an applicant’s recent job change, there are some red flags to look out for:
- Less than a 12-month history of commission income
- Bonus and overtime with less than a 12-month history
- Applicant has become self-employed with less than 12 months of filed activity
How to help borrowers: Explore all types of income your borrower receives monthly and determine which may be used as qualifying income. You may want to include a gap letter describing the changes.
Your Applicant Lied on the Mortgage Application
Believe it or not, some borrowers will lie on their mortgage application. The lies range from embellishment or padding of income to making up the past several years of employment history.
Material misrepresentations made by an applicant on a mortgage application is a federal offense, and you are legally bound as an underwriter to report any suspicious activity.
What to look out for: It is critical that ALL the information you are considering in your credit decision is accurate. Although the validation process can be lengthy, it is worth the effort to ensure your institution will be there to fund the loan for honest, credit-worthy applicants by assisting them in achieving the dream of homeownership.
You can learn more about fraud in some of our online courses.
How to help borrowers: In the case of fraud, there might seem like very little you can do to convince an applicant to be truthful on their application. As a best practice, you should let all your applicants know that misrepresentations made on a mortgage application are a federal offense.
Now that you have a better understanding of the typical reasons why a mortgage application is rejected, you’ll be better equipped to help your borrowers in the future by looking out for these problems early on.