Credit Education

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03. Aug, 2016

Being Turned Down for a Home Loan – “How Did This Happen?”

Most people dream of one day owning their own home. Many manage to achieve this dream, but for others the path to home ownership is littered with obstacles. Being turned down for a home loan is one of the biggest disappointments facing prospective home buyers, but they are in good company — the American Mortgage Bankers Association estimates that half of mortgage applicants receive rejections.

This article outlines some of the common reasons why financial institutions turn down home loan applications. Learning why a loan request was denied helps aspiring home buyers know the steps to take to increase the chances of getting their next loan request accepted.

Low House Value Appraisals
Banks only grant home loans when they believe the risk of losing their money is low. Houses are valuable assets, so if the borrower defaults, the bank expects to recover their money by repossessing the house. They commonly decline home loan requests if the property assessment shows it is worth less than the amount of the loan. US Federal law obliges banks to provide written explanations of home loan denials. Low property value appraisals have become the most popular reason for loan rejections.

Poor Credit Scores
First, banks want to find out the home loan seeker’s credit score. Credit bureaus calculate credit scores based on how the individual conducts their financial affairs over a certain period. Defaults on loans, delayed payments, and bankruptcies push down credit scores. The credit score tables that FICO (Fair Isaac Corporation) compile are the most popular in the USA. The FICO scale starts at 301 and maxes at 850. The typical American has a credit score of about 720. When banks see credit scores below 620, their warning bells start ringing – this person constitutes a poor credit risk. Loan seekers in this situation should expect to be turned down or offered a loan on very unfavorable terms.

Lacks income documentation or a steady employment record
In addition to good credit scores, banks like to see that loan applicants come with full income documentation. Even a financially comfortable person arouses suspicion if they lack the taxes and other records to back up their story. Bank managers are also put off by loan seekers without a record of steady employment or with frequent changes of address. The manager’s natural caution leans toward turning down these kinds of applicants.  

Unrealistic Aims
Even if the loan applicant has a good credit score, the bank wants assurances they can maintain loan payments. Imagine someone earning $40,000 per year who seeks a loan to buy a $2,000,000 property. Suppose they have no other income or savings. What’s the chance they can easily finance installments on this huge loan? It seems almost inevitable that they will get into difficulties – unless their financial situation dramatically improves. Usually banks turn down home loan applications if loan payments will exceed 38% of the borrower’s gross income. Financiers refer to this as a ‘too high’ debt-to-income ratio.

A Wrong Bank Choice
A home loan rejection from one bank doesn’t mean another bank is going to take the same view. Lending institutions offer various loan programs. They also differ in the way they make risk assessments and property appraisals. Remember that sometimes managers err in their judgments – one bank manager’s “high risk” might be a “reasonable risk” for the manager of another bank. This makes it worthwhile to continue with the home loan search.

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