Summary: There are several reasons why homebuyers may be denied when applying for a mortgage. Pre-existing debt can be one of these reasons. Debt is one of the more common reasons for loan denial in California and throughout the country.
When homebuyers have a great deal of debt, it is detracted from their income during the mortgage qualification analysis conducted by the bank. In some cases, debt reduces the amount of income below the necessary amount needed to cover future monthly mortgage payments.
Good News: Declining Rates of Mortgage Denials
A recent study showed that mortgage loan denial rates “have steadily declined” over recent years. Nationwide, the percentage of denied applications is lower than it was in the early 2000’s (during the housing boom). This means that a higher proportion of homebuyers are receiving loan approval.
But what about those who do get turned down for mortgage loans across California and the nation? What is the most common reason for denial? According to this study, the debt-to-income ratio was the single most common issue that affected loan approval.
Debt-to-Income Ratio – And Why It Matters
Definition: The debt-to-income (DTI) ratio compares the amount of monthly earnings (based on income before taxes) and the amount spent on recurring monthly debts. For instance, a person who uses 30% of his or her income to cover the monthly payments on credit cards, auto loan, and mortgage has a debt-to-income ratio of 30%.
Mortgage lenders are required to consider many variables when assessing qualification, but the DTI ratio is one of the most important. More than any other factor, falling short of DTI ratio requirements leads to denied loan applications.
The study reported that high debt-to-income ratios (DTI) were the culprit behind approximately 37% of home loan denials.
The second and third most common reasons for mortgage denial are related to credit history and available assets, respectively.
DTI Standards Are More Relaxed Today
Good news for buyers: Over the last few years, both Fannie Mae and Freddie Mac adjusted the maximum allowable debt-to-income ratios upwards for loans they purchase.
These government-sponsored enterprises (GSEs) increased their DTI limits from 45% to 50%. Today, home buyers today can qualify for a “standard” conventional mortgage loan with a debt ratio as high as 50%.
Here are the key takeaways for consumers:
- Mortgage lenders use debt-to-income ratios to help ensure that a borrower can safely repay their loan
- Debt-to-income ratio limits have eased in recent years. Certain mortgage programs currently allow DTI ratios of up to 50%.
- Despite this trend, DTI ratios are currently the most common reason for loan denial in California
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