What Would Make an Underwriter Deny a Loan?

Getting a mortgage loan denial can be devastating, especially if you’ve already made an offer on your dream home. While no one wants to hear those dreaded words – “your loan application has been denied” – it’s important to understand why underwriters reject loans so you can avoid it happening to you.

As an underwriter myself, I want to provide some insight into the main reasons we have to say no to a mortgage application. My goal is to educate you on the underwriting process and the most common red flags so you can get your loan approved the first time around.

What is Mortgage Underwriting?

First, let’s do a quick overview of what underwriting is. Underwriting is the process a lender uses to assess the risk of lending money to a particular borrower. The underwriter reviews the loan application and supporting documents to verify credit, income, assets, and other details. Their job is to determine if the applicant is financially stable enough to repay the mortgage loan.

Underwriting involves careful analysis of

• Credit reports and credit scores
• Income and employment
• Assets and reserves
• Liabilities and debt
• Collateral (the property)

Underwriters follow lending guidelines that specify the loan terms and borrower criteria needed for approval. Based on the findings, they will make one of three decisions:

• Approve the loan application as is
• Issue a conditional approval pending more information
• Deny the application

Now let’s take a look at the main reasons an underwriter may have to deny your mortgage loan application.

8 Top Reasons for Mortgage Denial

Here are the most common red flags that would prompt an underwriter like myself to reject a loan application

1. Low Credit Scores

Your credit score gives insight into your past repayment behavior Most conventional loans require a minimum score of 620 Government-backed loans like FHA allow scores as low as 500. But in general, the higher your scores, the better your chances of approval.

Multiple accounts in collections or a history of late payments will also hurt your odds even if your scores are above the minimums.

2. High Debt-to-Income Ratio

Your debt-to-income (DTI) ratio compares your total monthly debt payments to your gross monthly income. Most conventional loans require your DTI to be below 50%. For government loans, it should ideally be under 43%.

Too much existing debt like credit cards, auto loans, and student loans makes it hard to qualify. A high DTI signals you may not be able to afford the new mortgage payment.

3. Insufficient Credit History

Lenders want to see you’ve successfully managed credit for a few years. Typically, they look for at least 3-4 open and active credit accounts with 12 months of positive payment history.

If you’re a first-time buyer with limited credit history, it can cause your application to be denied.

4. Job Gaps or Employment Changes

Having stable income stream is vital for underwriting approval. We need to document you’ve been continuously employed in the same line of work for at least 2 years.

Any gaps in employment greater than 30 days have to be explained in writing. Underwriters get nervous about new jobs since income can’t yet be established.

5. Inaccurate Information

All documents submitted with your application must be complete and consistent. Any discrepancies between your loan application, pay stubs, tax returns, bank statements, or credit report will raise concerns about potential fraud.

Conflicting information must be clarified and verified before your loan can proceed.

6. Large Cash Deposits

Underwriters scrutinize bank statements to source where your down payment and closing cost funds are coming from. Large recent deposits from unknown sources are red flags for potential borrowed funds.

You’ll need to provide documentation proving the deposits are from your own savings or gifts. Loans and undisclosed debts won’t be allowed.

7. Low Home Appraisal

The property value determined by the appraisal has to be equal to or higher than the purchase price. If the appraisal “comes in low”, your loan would be denied unless you can renegotiate the price or supplement more down payment.

8. High Loan-to-Value (LTV) Ratio

Your LTV ratio compares the loan amount to the home’s appraised value. Conventional loans generally require LTVs of 80% or lower. The lower the ratio, the less risk for the lender.

Minimum down payments are typically 15-20% of the purchase price. Coming in with less down would lead to denial.

How to Get Approved: Tips to Avoid Denial

Now that you know the major reasons for underwriting denials, here are my tips to improve your chances of getting approved:

• Maintain good credit – Check reports for errors. Pay down balances. Don’t apply for new credit before applying.

• Reduce debt – Pay down credit cards and loans. Consolidate payments if needed.

• Document income/employment – Explain gaps in work history with letters. Gather recent paystubs.

• Save for down payment – Have at least 15-20% of home price plus closing costs.

• Explain cash deposits – Get gift letters for money from relatives. Document savings sources.

• Be upfront – Disclose all income, assets, debts. Clarify red flags early. Provide lots of documentation.

• Work with an experienced loan officer – They can advise you on qualifying and guide your application through underwriting.

• Check your loan limits – Make sure you qualify for the loan amount and property you want. Get pre-approved.

• Allow enough processing time – Ask how long underwriting will take and be responsive to provide anything extra needed.

Following these tips will significantly increase your chances of getting an underwriting approval. While most applications are approved, it is possible to get denied even when you think you’re in good shape. But don’t get discouraged if this happens! Find out the reason for the denial, rectify the issue, and resubmit your application.

The Takeaway

The underwriting process is designed to verify you meet the requirements to qualify for a home loan. While rejection is disheartening, understand that underwriters are just doing their jobs in assessing risks to the lender. The keys are having realistic expectations about what it takes to get approved, being patient and persistent, and working closely with your loan officer to put your best foot forward.

With a little education on the underwriting process, you can avoid the pitfalls that would lead to a denial. Taking steps to better your credit, manage debt, and document income will help ensure your loan application sails through successfully. You’ll be that much closer to getting the keys to your new home.

Yes, mortgage underwriters analyze spending habits as part of the loan application process.