Reasons For Mortgage Loan Denial During Mortgage Process

In this article, we will discuss and cover the reasons for mortgage loan denial during the mortgage process. A mortgage loan denial is when a mortgage underwriter denies the home loan application because borrowers do not either meet the federal minimum mortgage lending guidelines or the individual lender overlays. There are reasons for mortgage loan denial which can be avoided. Every loan program has its own minimum lending guidelines set by the loan program. For example, HUD sets all lending guidelines for FHA loans. The Department of Veteran Affairs creates and implements mortgage guidelines for VA loans. Rural Development sets standards and lending guidelines for USDA loans. Fannie Mae and Freddie Mac set mortgage lending guidelines for Conventional loans.

What Are Overlays By Lenders

Besides federal minimum lending guidelines, each individual lender can have their own lending requirements and lending guidelines that are higher standards than the federal minimum lending guidelines. These additional lending guidelines are called mortgage lender overlays. For example, to qualify for a 3.5% down payment FHA loan, minimum credit score requirements are 580. However, banks and mortgage companies may have FHA lender overlays where they may require a minimum credit score of 640 which is substantially higher than FHA’s 580 credit score requirements. This is perfectly legal and very common among most lenders.

What Are Lender Overlays?

Overlays are each lender’s own lending requirements that are substantially higher than those required by FHA. Another common lender overlays are DTI Overlays. FHA allows up to a 56.9% debt to income ratio for borrowers with at least a 620 credit score. Most banks and lenders have overlays on debt-to-income ratios on FHA Loans. They may cap the debt to income ratios to a maximum of 45% to 50% although FHA caps it at 56.9%. Overlays on collection accounts are other common lender overlays. FHA does not require borrowers to pay off outstanding collection accounts and charge off accounts in order to qualify for FHA Loans.

Typical Lender Overlays By Mortgage Companies

Many banks and lenders have overlays on collection accounts and charge-off accounts. They require borrowers to have all collection and charged-off accounts paid off and have a zero balance even though FHA does not require it. Gustan Cho Associates is a mortgage company licensed in multiple states with no lender overlays on government and conventional loans. Gustan Cho Associates has no lender overlays on government and conventional loans. We just go off agency guidelines and have ZERO OVERLAYS on FHA, VA, USDA, and Conventional loans.

Most Common Reasons For Mortgage Loan Denial

The most common reason for mortgage loan denial is due because the mortgage loan originator has not pre-qualified the mortgage loan borrower. Mortgage loan officers need to make sure borrowers are qualified with regards to credit, credit scores, payment history, income, and waiting periods after bankruptcy and foreclosure. There is no reason why borrowers should get a mortgage loan denial if the borrower was pre-qualified properly. Just taking the mortgage loan application and pulling the borrower’s credit to see if they meet the minimum credit requirements is not sufficient to warrant a solid pre-approval letter.

Credit Disputes Is On Top Reason For Mortgage Loan Denial

The loan originator should not just look at the credit scores of the borrower but also carefully review the borrower’s credit report and make sure there are no credit disputes:

• All credit disputes need to be retracted and removed prior to submitting the mortgage loan package to the mortgage loan processing and underwriting department
• Credit disputes during the mortgage processare not allowed
• There are many loan officers who submit the mortgage loan package to processing and underwriting with credit disputes
• When the file gets assigned to a mortgage loan underwriter and notices credit disputes, the file is suspended
• It is kicked back to the loan officer
• Borrowers need to have them have the credit disputes retracted

Retracting Credit Disputes Lowers Borrowers Credit Scores

Unfortunately, retracting credit disputes will lower a borrower’s credit scores. Mortgage loan applicants with 580 credit score barely meets the FHA minimum credit score requirements for a 3.5% down payment home purchase FHA Loan. The minimum FHA credit score requirement to qualify for a 3.5% down payment home purchase loan is 580. However, if the borrower has a 580 credit score with credit disputes and the mortgage underwriter suspends it and kicks it back to the loan officer to have the credit disputes removed. Chances are borrower’s credit scores will drop and the borrower will no longer qualify for the 3.5% down payment FHA loan due to their credit scores falling below 580 credit scores.

Reasons For Mortgage Loan Denial Due To Marginal Debt To Income Ratios

Another common reason for mortgage loan denial is due to high debt to income ratios. Mortgage loan originators should carefully go over figures and expenses on borrowers with high debt to income ratios. For example, if a borrower with a 56.9% DTI has any added expense such as higher than anticipated property taxes, homeowners insurance, or homeowners association than originally anticipated, this will result in a mortgage loan denial. It is always highly recommended that higher debt to income ratio borrowers have a non-occupant co-borrower on stand by in the event if they go over the maximum debt to income ratio permitted.

Qualifying Income Prior To Entering Into Purchase Contract

There are times where loan originators use part-time income, bonus income, and overtime income to qualify borrowers:

• However, there are times where mortgage underwriters will negate the part-time income, bonus income, and overtime income if the income is declining from one year to another
• The income that needed to be used to qualify borrowers can no longer be used
• This can be the reason for mortgage loan denial

Another reason for mortgage loan denial due to high debt to income ratios is when the loan originator did not calculate that the borrower is purchasing a home in a flood zone. Homes in a flood zone require mandatory flood insurance and flood insurance can be quite expensive. Homeowners’ insurance and flood insurance quotes should be provided and reviewed by the mortgage loan originator on borrowers with high debt to income ratios prior to the issuance of a pre-approval letter.

Ways Of Avoiding Mortgage Loan Denials

As long as borrowers have been properly qualified, there should be no reasons for mortgage loan denial. Not all mortgage loan applications are the same. There can be many different case scenarios and sometimes the guidelines can be vague. When loan officer has questions on mortgage guidelines, they should consult with the underwriting department’s loan scenario desk.

Getting Second Opinions From Mortgage Underwriters

Loan officers should run the case scenario with an underwriter before submitting a mortgage loan file. Special attention needs to be addressed on the actual start date of waiting periods after foreclosures and deed in lieu of foreclosures. FHA and Fannie Mae have strict start date waiting period start dates to qualify for a mortgage after foreclosure and deed in lieu of foreclosures. The start date of the waiting period is not the date that the property was surrendered but the date of the sheriff’s sale and/or the date that the homeowner’s name was transferred out into the name of the mortgage lender.

Can Reasons For Mortgage Loan Denial Be Avoided?

Reasons for mortgage loan denial can be avoided.  The best way of avoiding reasons for mortgage loan denial is by having a diligent experienced loan officer properly qualify borrowers. Loan officers need to make sure borrowers meet all federal lending guidelines and their lender overlays. Gustan Cho Associates is a national direct lender with no overlays on government and conventional loans.