Understanding the Most Common Reasons for Rejection
Rejection is an inevitable part of life, but when it’s a mortgage loan application that gets rejected, it’s not as easy as “getting over it.”
Denied mortgage loans can shake up your future and derail years of planning.
Let’s be blunt here: it really sucks!
Of course, knowing why mortgage loan applications get denied can help you anticipate and avoid it outright, or get back on track afterwards.
Whether you’re trying to cope with a denied application or hoping to prevent rejection in the first place, start by learning exactly why mortgage lenders decide to deny applications.
Here are 15 of the most common reasons banks and mortgage companies reject an application:
1. Car Loans
Cars loans are one of the main factors why borrowers don’t qualify for the mortgage loan they decide. For every $500 in car payments, it limits a borrower mortgage eligibility by $100,000. This can make a significant difference in your pre-approval amount!
If you’ve bought a car in the time since your mortgage loan application was pre-approved – then your car loan may be a reason for a future rejection.
2. Changes to Your Credit After Qualification
Did your credit activity change after getting pre-approved for a mortgage?
If you open new lines of credit or make big purchases after your initial qualification, your lender’s earlier decision might be irrelevant now.
3. Inadequate Employment History
Mortgage applications always cover the past three years of your work history, but underwriters are also looking at your current employment trend and career as a whole.
Lenders want to see a consistent, stable source of income, as well as job experience that shows you’re capable of earning an adequate income in the future—after all, they want to make sure they’re lending money to someone who can pay them back.
If you changed jobs frequently, started a new career, or have a lot of gaps in this two-year period, lenders may need more proof that you’ll have an ongoing source of income.
4. Lack of Credit
Your credit history is proof to lenders that you can keep up with loans and pay your bills on time.
While you can take steps to get approved for a mortgage with bad credit, it’s trickier to prove your financial responsibility with little or no credit history.
Fortunately, opening credit cards and waiting another year or two isn’t your only option.
Some alternative lenders and private mortgage lenders consider “non-traditional” credit histories, including documentation from landlords, utility companies, and other parties you’ve paid regularly. In fact, in some cases and exceptions, this can even get accepted by best rates and terms lenders. A good example of an acceptable time to use these as sources of credit would be if you are new to Canada.
5. Unpaid Tax Liens or Judgements
Unpaid taxes are huge stains on your credit history, especially if the government took legal action to collect your unpaid debts.
Fortunately, if your tax liens were withdrawn long ago, you may be able to file a dispute or request a removal from your credit report.
6. Business Debt
As a sole proprietor business owner, all your financial liabilities are relevant to lenders.
That means your business expenses and loans will be part of your overall debt-to-income ratio calculations.
If your loan application was rejected and you have outstanding business debts, you may need to pay down debt or liquidate assets in order to improve your ratio.
7. Down Payment Source Isn’t Acceptable
Not all down payments come directly from a savings account, but if you’re using a different source of funds, it must be acceptable to your lender.
Is the source of your money easy to verify? Can you prove it’s not another debt? For example, if you plan to use money you received from a loved one, the financial institution will require the family member sign a gift letter to confirm this is not a repayable loan. You should also be able to explain it and trace it back to them.
8. You Are Self-Employed
Unfortunately, lenders don’t always reward the entrepreneurial spirit.
If you’re a freelancer, contractor, or business owner, you depend only on yourself for your monthly income.
As mentioned earlier, lenders prefer a more stable safety net, but extensive documentation and a long work history could redeem you. Lenders who offer the best rates and terms on mortgage loans will require a two-year history of your income tax returns to adjudicate whether a borrower qualifies.
For more information on getting a mortgage when you’re self-employed, check out our rundown here.
9. Tax Return Errors
Were your tax returns inaccurate?
Lenders will dissect your tax return, as well as financial and employment records that cover the same years.
If there are discrepancies, they cannot verify your income to their satisfaction. Re-apply after amending your tax returns to correct the record.
10. Not Enough Savings
Before you borrow enough money to buy a house, you must demonstrate that you have the funds to pay it back.
Your income is an important factor, but so is your savings account, because that’s what you’ll need in case of emergency expenses or sudden unemployment.
11. Down Payment is Too Small
Are you putting enough money down?
If your down payment is less than 20 percent of the purchase price, it will be harder to qualify, given the mortgage application must abide by the mortgage default insurer rules which are more strict than the lender guidelines.
12. Income to Debt Ratio Isn’t Documented
Lenders need concrete proof that your monthly income isn’t swallowed up by debts.
Lenders offering best rates and terms need adequate sources of income including but not limited to a letter of employment, recent pay stub, income tax returns. Similarly, lenders may need your tax returns, pay stubs, employment records, and documentation of all your debts and other fixed monthly expenses.
13. History of Bad Credit
Did your credit score improve in the months or years before you applied for a mortgage loan?
If you’ve had poor credit in the past, a new and improved score may not be impressive enough to counteract a spotty history.
Late or missed payments, defaulted loans, and other red flags may tell lenders that your financial improvements are only temporary.
14. Change in Interest Rates
Given financial institutions are required to abide by federal rules (called the stress test), lenders must act as though you are applying for your interest rate +2% for qualification. This means, if mortgage interest rates go up, a borrower’s application gets adjudicated at the higher rate +2% so it makes it even more difficult to qualify for a mortgage.
Of course, this is only true for borrowers who have more than 20% of the purchase price as a down payment. All files where the down payment is less than 20% of the purchase price are subject to a stress test qualifying rate of 5.34%.
15. You Weren’t Honest with Your Lender
Of course, if your mortgage pre-approval was based on factors that weren’t accurate, your lender will find out.
Undisclosed debts or unreported income changes may come up during the underwriting process, increasing the risk to the lender and making you look unreliable. It’s always, always, always important to provide proof of income documents during the pre-approval stage! This will help ensure your pre-approval is authentic and properly underwritten, preventing future headaches.
Your Next Steps
Was your mortgage application rejected for one or more of these reasons?
Before you appeal the rejection or re-apply with a different lender, address the factors that make you look like a financial risk. Speak to your Mortgage Broker about this.
Your goal is to buy a house you can actually afford, and your broker can help you decide what needs to change in order to qualify for from any lender.
No matter what your financial situation, working with a real estate professional and providing extensive documentation are two crucial ways to improve your odds and prevent any surprises after the initial pre-approval.
Chris Allard’s experience in the field means he can get you offers with over 50 financial institutions lending in Ottawa. Every lender has many mortgage products they offer, which means Chris and his team will make sure a mortgage caters to your needs while also ensuring you get a competitive rate. Chris Allard is a proud mortgage broker of Smart Debt Mortgages, independently owned and operated. Smart Debt broker #12236.