The Top 3 Reasons Loans are Denied
Why are loans denied?
- Credit score.
One of the first things a lender will look at is the borrower’s credit score. We’ve written a lot about credit scoring and how it works, including our free online course, Understanding your Credit Report and Scores. The credit score will be affected by the length of your credit history, credit utilization, payment history, and more.
- Recent credit history/Bankruptcy.
The info on your credit report isn’t just turned into a score—your lenders will review the whole report and look for anything that makes you look like a risky borrower. If you had a recent bankruptcy, you recently applied for a lot of new credit, or you have some unpaid collections or legal judgments, then you can be denied even if your credit score is technically good enough to get a loan.
- Debt-to-income ratios.
A major reason lenders reject borrowers is the debt-to-income ratio (DTI) of the borrower. Simply, a debt-to-income ratio compares one’s debt obligations to his/her income on a monthly basis. So if you earn $5,000 per month and your total debt payments are $2,000, your DTI is 40%. This is also known as your “back-end ratio” if it includes all of your debts, like mortgage, credit cards, auto, student loans, and more. Your “front-end ratio” only considers your mortgage payment compared to your income.
These ratios are expressed as front/back. So if your monthly income is $5,000, your mortgage payment is 1,200, and your total debt payments are $2,000, your ratio is 24/40.
Please note the mortgage payment is included in both calculations. The back-end is different in that it also includes other debt obligations. Things like child support and alimony are considered a kind of debt and are included in the back-end ratio.
How to overcome these reasons for denial?
- When it comes to your credit score, fixing the underlying data is your top priority. Make sure your credit report is accurate and up-to-date. Many reports have errors that can lower your score and keep you from getting loans. You can also pay off accounts, remove outdated debts, and bring delinquent accounts current to make sure your credit score is accurate and healthy.
- A recent bankruptcy can derail a loan application, but there are lenders who will still work with you. Our Back to Work Program counseling can help you access the FHA program that allows buyers with credit problems or recent bankruptcies get a loan. You also need to make sure your credit report is updated properly; if old debts that were discharged by the bankruptcy filing are still listed, they can be unfairly damaging your score. You can add a 100-word statement explaining the circumstances of your bankruptcy. These statements can go a long way toward helping a lender understand your situation and make the right lending decision. (See our post on Adding a 100-word statement to your credit report.)
- Improving your debt-to-income ratios can involve paying down debt, increasing income, or doing something to adjust your mortgage payment. There are a lot of strategies that you can use to improve these numbers and increase your chances of getting approved.
Is there counseling that can help?
We’ve been providing free, confidential credit and debt help to the community for 40 years. Our Loan Denial Assistance hotline can pair you up with a professional counselor who can help you understand the reasons for your loan denial, and create a plan to help you qualify for the loan.
Call us today at 800-294-3896 and we’ll give you the tools to improve your debt-to-income ratios and build a better credit profile going forward.