What are your chances of getting denied after pre-approval? Even though you may have gone through the process of being qualified and approved, there is no guarantee of final approval. It is possible to be pre-approved and unsuccessfully obtain the financing to buy your new home.
The most problematic time for this to happen is right before closing. Denial before closing creates a lot of heartbreak and negative emotions.
To avoid any heartbreak, we’re breaking down the reasons a pre-approval is denied by underwriting and how to give yourself the best chance at successfully obtaining financing.
It all starts with understanding the framework underwriters and lenders operate within. Once we do that, the article dives into the specific tactical reasons a mortgage is denied after pre-approval.
An Underwriters Perspective
If you read a lot of content on this site, you will find that the Dolinski Group focuses on providing simple frameworks and philosophies before diving into the tactical information. Our Lansing real estate agents believe in arming you with the best information possible to help you make educated decisions that are best for your situation.
This article is no different… Before going into all of the reasons your mortgage is denied after pre approval, let’s look at a high-level framework in credit risk analysis.
When you’re seeking a mortgage, there is an underwriter that looks at your financial picture — credit score, income, profession, debt levels, debt-to-income ratio, down payment, loan type, and more.
The underwriters job is to approve or deny mortgages based on risk calculated from a proprietary risk-assessment model and a lender’s management policy for risk.
In other words, an underwriter is looking at your situation and they are calculating a risk score for you. For example, a lender may calculate all potential home buyers between 0 and 100, where 100 is the greatest risk and zero is no risk at all.
Given current market conditions, the lender decides they want to approve all applicants with a risk score below 40. Any home buyer above 40 will get denied.
As a home buyer, all of this means that you must do everything possible to reduce your perceived risk score. This gives you the greatest chance at getting approved and staying approved.
It’s impossible to know every single factor that goes into calculating an individual risk score, but we do know many common factors.
Keep this simple thought in mind: take actions that reduce your overall risk factors and avoid any actions that increase your risk factors.
Let’s explore some of those risk factors that lead to high chances of getting denied after pre-approval.
Increased Debt Levels
A 60-year-old woman was moving to a lake house in Haslett, Michigan. She worked hard for years to save up this kind of money and was finally buying her dream home.
Preparing for the move and amidst her excitement, she found herself at a dealer buying a brand new pontoon boat…
…On credit.
Her debt levels increased and the debt-to-income ratio was pushed too high. As a result, she was denied the mortgage one week prior to closing.
While many of us can’t relate to buying a lake house and new pontoon boat, her situation is fairly common.
Buyers are denied after pre-approval because they increase their debt levels beyond the lender’s debt-to-income ratio parameters.
The debt-to-income ratio is a percentage of your income that goes towards debt. When you take on new debt without an increase in your income, you increase your debt-to-income ratio.
When this happens, it’s possible to go above the lender’s approval level.
For example, let’s say you earn $4,000 per month. Between credit cards, an auto loan, or school loans, you find yourself paying $1,000 per month. You have a 25 percent debt-to-income (DTI).
DTI is calculated as follows:
Monthly debt payments / income or $1,000 / $4,0000
Here’s a more common example of what happens. A home buyer in excitement goes out and purchases new furniture. They put it on credit. The monthly payment is $300 per month for twelve months.
Their overall debt is pushed to $1,300 and their DTI is pushed to 32.5 percent. For some lenders, a DTI above 30 percent can cause a mortgage denial.
Solution: Reduce Debt, Add Income, or Switch
To improve your chances of mortgage approval, you need to lower your debt-to-income ratio or keep it at the levels when you were approved.
If you look at the debt-to-income ratio formula, you have two options for lowering your debt-to-income ratio. You can either reduce your debt or add more income.
At the very least, you should not buy anything on credit, even if you don’t need to make payments or it is at zero percent interest.
Once you have your offer accepted on a home and prior to closing your motto should be: “I will not buy anything unless I have the cash to pay for it.”
I do not care what it is you want or need. If you don’t have cash. You’re not buying it.
If you’re reading this article because you were just denied a mortgage after a pre-approval, then look into switching your mortgage type. Each mortgage type — FHA, VA, conventional — have different requirements on debt-to-income ratios.
There are some FHA loans that will go as high as 40 to 50 percent on debt-to-income ratio.
Credit Score Drop
For many reasons a drop in your credit score can result in getting denied after pre-approval. First, an underwriter will see you as a higher risk if your credit score drops. Second, it’s possible a lower credit score means a higher interest rate, which could make the monthly payments unaffordable.
A credit score is calculated by looking at your amount of debt, length of accounts, payment history, new credit, and type of credit. Your credit score represents, according to FICO, your ability to pay back a mortgage.
Many underwriters heavily weigh your credit score when trying to decide whether to approve you for a mortgage or not.
Any negative change in your credit score will increase the chances of getting denied after pre-approval. Every lender and mortgage type has very specific requirements for your credit score.
If your credit score was hovering around the minimum requirements, like 620, you need to be the most careful. A missed payment during the home closing process will drop your credit score below the minimum requirement.
The solution is to manage your credit score.
Solution: Manage Your Credit Score
Once you have found your home and prior to closing, avoid any actions that negatively affect your credit score. These would include:
- Closing Old Credit Accounts: now may not be the time to go all Dave Ramsey, cut up your credit cards, and close your accounts. Do it after closing.
- Increasing Debt: As mentioned above, do not take on new debt. You can cut up your credit cards, just do not close the accounts.
- Missing Payments: Do NOT miss any payments to your creditors. Pay your rent, utilities, and credit cards on time.
Focus on keeping your credit score at the current level or improving it. When in doubt, ask your lender what might affect your credit score.
Insufficient or Unexplained Funds
Insufficient or unexplained funds, at best, result in additional paperwork you need to send to the underwriter. At worst, it can cause a pre-approved mortgage to be denied.
Underwriters really don’t like anything out of the ordinary. Large or abnormal deposits or withdrawals from your account raise a red flag. It appears very suspicious to lenders and could indicate issues with paying your mortgage.
When it comes to large deposits, underwriters hate to see large deposits because there are specific mortgage rules when it comes to gifts from other parties. For example, home buyers can only accept certain dollar amounts from relatives, like Grandma.
On the note of your funds, you need to make sure there are sufficient funds in your bank account for closing costs and the down payment.
You can get help paying for your closing costs through seller’s concessions and you can get help with your down payment from a Michigan down payment assistance program like MSHDA.
Either way, an underwriter wants to see sufficient funds. Do not dip below this amount of money needed for closing and down payment. It can result in a mortgage denial.
Solution: Separate Accounts
It is a good idea to have a separate account for your closing costs and down payment. Leave the money in that account and do not touch the money.
The money can be held with the same bank for convenience. For example, many banks offer a checking and savings account. Avoid having your closing costs and down payment commingled with your everyday checking account.
Otherwise, you risk overspending and dipping into the funds for closing. The more barriers you can put up, the better. If you have a hard time controlling your spending, consider putting the money in a separate bank account entirely.
Throughout the home buying process, consider adding to your savings to create extra cushion. Any funds remaining after closing can be used for purchasing new furniture, making repairs, or any other expenses you would incur after closing on a home.
Changes In Employment Or Income
Your profession and the stability of your career is a variable underwriters use to calculate your risk score. Changing jobs or industries could increase your risk score and increase the chances of getting denied after pre-approval.
As a simple rule, lenders are looking for stable employment over a two year period.
Every lender and loan type differs on what they are willing to accept when it comes to changes in employment. Prior to making any career decisions, it is best to consult with your mortgage lender and the potential effects on your pre-approval.
Some career and employment moves are safer than others. Certain moves can cause your pre-approval to be denied.
A change in employment is generally acceptable if it’s in a similar field. For example, a buyer who is a registered nurse switches hospitals, but remains a nurse with a similar income.
Alternatively, a registered floor nurse may stay within the same hospital, but become a charge nurse with an increase in income.
Again, verify your situation with your mortgage lender because not every lender is okay with career moves.
If you’re buying a home, switching industries and professions are likely to lead to a mortgage being denied.
For example, if the registered nurse decides to become a teacher or a health consultant, there is a good chance that a lender will deny the loan and require you to start the pre-approval process all over again.
Solution: Keep Stable Employment
If you’re planning to make big career moves, plan to do it after closing on your home. Otherwise, consult with your mortgage lender before the move.
They can help predict whether it will increase your odds of getting your mortgage denied.
In some cases, home buyers will get laid off from their employment during the homebuying process. If this occurs, look for employment in a similar field and with a similar employer. Also, notify your lender if this happens.
Lender Guidelines Change
Remember, underwriters are looking for specific risk scores and approving home buyers within an institution’s guidelines.
When the overall real estate market changes or a new CEO comes on board, it’s possible for the lender to change their lending guidelines
For example, with rising interest rates, many lenders are becoming more strict on their guidelines so they can sell the mortgages in the secondary market. In high interest rate markets and market uncertainty, banks look to offload their loans to the secondary market.
To sell their loans, they need to issue loans that are attractive. As a result, they approve loans with less risk.
As an example, a lender may approve loans with a debt-to-income ratio of 40 percent, but they implement guidelines to accept loans with debt-to-income ratios below 30 percent.
Even though you did nothing wrong to increase your risk, the lender decided your risk was too high under the new guidelines.
There are no specific solutions for dealing with this situation if it happens. You can follow the steps above to reduce your overall risk picture, go to a new lender, or switch loan types.
Appraisal Issues
A majority of mortgage pre-approvals are conditional on a satisfactory bank appraisal. Meaning, the home has to meet specific requirements and guidelines.
These vary based on lender and loan type. For example, a USDA loan can only fund the purchase of a home in an approved USDA zone. A MSHDA loan with a $10,000 down payment assistance is only approved in specific zip codes.
An issue with the bank appraisal is fairly common. The solution focuses on solving the underlying problem.
In some cases, it means repairing the home to meet requirements. Other times it means switching loan types.
Your real estate agent and lender can guide you through the exact steps to take if your mortgage is denied after pre-approval because of a bank appraisal issue.
You Were Never Pre-Approved
In a few small cases, a homebuyer only believes they are pre-approved. A misunderstanding arises when there is a lack of communication or shared knowledge between a lender and home buyer.
It’s common to misunderstand the difference between a pre-qualification and pre-approval. There are times when buyers believe they are pre-approved, when in fact, they are only pre-qualified.
The real estate industry has a lot of lingo and separating the difference between some words is trying to split hairs. A lender may use “pre-approval” as a simple way to explain to the home buyer or a home buyer might believe a pre-qualification is the same as a pre-approval.
A pre-qualification is a lender’s opinion on whether you would get approved for a mortgage. It’s a high level view of your financial picture. It should not be used as a pre-approval.
Before you go house hunting and write offers on homes, make sure that you are fully pre-approved.
When in doubt, ask your lender and your real estate agent. A pre-approval carries more weight and is one step closer to being fully approved for a mortgage.
How to Make Sure Mortgage Is NOT Denied After Pre-Approval
Let’s summarize all of our main points up to this point. These are the specific steps you need to take to make sure your mortgage is not denied after pre-approval.
As a simple framework: try to keep everything the same as when you were pre-approved for a mortgage. This is easier said than done, especially if your house hunting process stretches from months or over a year.
Here are the specific steps:
- Reduce your monthly debt payments. It’s a good idea to pay down or pay off credit cards, but do NOT close any accounts.
- Do NOT open up any new lines of credit. Do not go out and buy furniture, new cars, or a boat.
- Use cash is the mantra until you close on your home.
- Pay your debts to avoid growth. You do not want your debt amounts to grow because of the interest rate. You need to make sure your debt is in control. For debt payoff, look into the snowball technique by Dave Ramsey.
- Do NOT make any large money movements into or out of your account.
- Keep employment the same. If not possible, consult with your lender before ANY move.
- Continue to save money for closing. Do NOT commingle funds together.
- Provide all requested documents in a timely fashion.
Final Thoughts
Every home buyer’s situation is unique. Your best bet is to work with a local, informed lender and communicate with them throughout the process.
If you take nothing else from the article, your priority is to communicate with your lender. If your lender is hard to reach, which is common with big name, online lenders, then seek out a smaller lender.
They can often give you the personal touch that you need and are true guides throughout the lending process. Rely on the experience and wisdom of your mortgage lender.
