They are the three biggest snares for home buyers seeking mortgages, and if you focus on them in advance you’re much less likely to have your application denied. This is especially true if you’re buying — or planning to buy — your first home.
So what are they? A recently completed Federal Reserve study covering millions of mortgage applications found that flunking the debt-to-income (DTI) test is the No. 1 reason that loan applicants get rejected.
No. 2: Issues over credit histories and scores.
No. 3: Property valuation problems, such as signing up for a house at a price higher than the actual market value.
They all spell trouble.
The study tapped into the massive databases compiled from federally mandatory reports that lenders file regarding mortgage applications. During 2015, according to researchers, 1 of every 8 loan applications for home purchases (12.1 percent) ended in a rejection. Denials were higher — nearly 14 percent — for borrowers seeking government-backed loans (FHA, VA, USDA), and lower — 10.8 percent — for those applying for conventional mortgages eligible for purchase by investors Fannie Mae and Freddie Mac.
Turndowns because of excessive DTI ratios accounted for nearly a quarter of all denials (23.4 percent); credit issues were connected with 20.4 percent; concerns over property valuations contributed to 13.7 percent.
Debt-to-income ratios are crucially important to lenders. If yours is too high, it suggests that you’re reaching beyond your ability to repay the loan: You’ve got too heavy a monthly debt load and not enough household income.
Say you have $6,000 a month in verifiable income, but your auto loans, credit cards, student loans and other monthly credit obligations come to $1,000. If the mortgage you’re seeking will cost you $2,500 a month in principal, interest, taxes and insurance, your total monthly debt obligations will eat up 58 percent of your income — a DTI of 58.3 percent. That’s way too high for most lenders and not a smart idea for you personally. You’re likely to be turned down.
Far better if your income is $7,000 a month and you apply for a mortgage requiring lower payments — say, $2,000. Now your DTI is 42.8 percent, which squeezes you just under the federal 43 percent eligibility cutoff for a “qualified mortgage.” Fannie Mae and Freddie Mac may allow you to go to a 45 percent DTI, and FHA can stretch the limit a bit higher, but the fact remains: The lower your overall DTI, the safer you look to the lender and the less likely you are to be rejected.
Joe Petrowsky, a mortgage consultant with Right Trac Financial Group in Manchester, Conn., says student loans are major DTI killers for many applicants whom he sees. “They’re a huge issue” for first-time buyers because these loans get factored into monthly debt calculations — and, in the case of FHA loans, even when payments are in deferred status.
Credit issues are in the same killer category. If there are serious dings on your credit reports because of late payments and if your FICO credit scores are depressed as a result, your application could be doomed at the gate. Of particular concern here: High “utilization” of your available credit. If you’ve got a $3,000 maximum limit on a credit card, don’t let your unpaid balance get much beyond $1,000 (33 percent) or your score could begin to suffer. Absolutely avoid maxing out. Ditto on all other credit accounts with limits. The lower the utilization percentage, the better.
Gene Mundt, a mortgage originator with American Portfolio Mortgage in Palatine, Ill., says credit reports and scoring are such mysteries to so many borrowers that it’s best to contact a loan officer four months before submitting an application. That way, he told me, “there’s enough time to work on and correct” whatever problems could eventually lead to a rejection.
Appraisal issues might seem to be beyond a home buyer’s direct control: After all, the lender hires the appraiser, not the buyer. But there’s one thing that you can avoid: getting sucked into a bidding war that pushes the contract price beyond true market levels. According to valuation and analytics firm CoreLogic, 11.3 percent of home purchase appraisals ordered through that company’s widely used system came in below the contract price.
Mundt’s blunt advice: “Don’t be the ‘winner’ in a bidding competition” that gets so out of line that it ultimately causes the mortgage financing to fall through. That’s called losing.
Ken Harney’s email address is firstname.lastname@example.org.