One roadblock does not equal the end of homeownership dreams.
You've decided to do it: You're going to take the plunge and buy a home. You apply with a local or online mortgage lender, only to receive word that your application has been denied. While it's disappointing, you're not alone. Mortgage denials happen to a lot of people. The first thing you should do is pick yourself up, dust yourself off, and explore your other options.
According to the Equal Credit Opportunity Act, if credit played a role in your loan denial, lenders must provide you with a letter laying out specific details. Here are the four primary reasons loans are denied:
- No credit: If you're just starting out, you may not have had time to build up enough credit history to make a lender feel confident about lending to you.
- Low credit: Your credit score tells a lender how you've managed credit in the past. If your score is low, the lender will worry that you might not repay a mortgage loan as promised.
- Job change: Lenders love it when you've been in the same job for a while. It makes them feel confident that you're not going to quit your job to join the rodeo the moment you close on a house.
- A sudden influx of cash: Suppose a lender looks at your bank accounts and notices a large, unexplained cash deposit. In that case, it naturally starts thinking one of two things: Perhaps someone loaned you the money, and you're going to have to repay it. Or perhaps the money is dirty, and there will eventually be an episode of Law and Order based on your exploits. The lender would like to avoid either situation.
Different mortgage lenders have varying appetites for risk. While one lender may have turned you down, another might find you the "ideal" candidate for a loan. If the reason the first lender denied you was insufficient credit, you can apply for a loan through a lender that specializes in mortgages for poor credit.
However, if your loan application is approved, you can expect to pay a higher interest rate. That's because this lender's business model is "greater risk for a greater reward." In this case, earning more interest on the loan is the reward.
Just remember that applying for a loan will ding your credit score slightly. As you shop for a mortgage, make it a point to apply for all loans during a short time period (two weeks should be sufficient). That way, the credit reporting agencies recognize that you're rate-shopping, and you'll only be dinged once, even if you apply with a dozen different lenders during that window.
Explore owner finance
Ask your real estate agent to help you locate properties offering owner finance. Here's how that generally works: You make a down payment and sign a loan agreement (as you would on any property). You make a monthly payment based on the agreed-upon interest rate directly to the owner for a set number of years (typically five to 10). At the end of that fixed period, you have a balloon payment due. You then refinance the loan with a mortgage lender and pay the balance due, or sell the property and pay the balance.
Owner-financed homes can be tough to locate in a hot seller's market, but it's an option worth exploring.
Regroup and try again
If an owner-finance deal is a no-go and you can't find a lender to approve your loan at an interest rate you can afford, it might be time to address the issue that prevented you from landing a mortgage.
Perhaps you just need to stay in your job a bit longer or provide proof of a cash source. Or maybe you need to take time to build a long enough credit history to make lenders confident in your ability to repay.
If a low or bad credit score is an issue, here are some steps that can help you boost your score:
- Check your credit reports. One in five Americans who check their reports finds at least one error. Even one mistake can decrease your score. Your first step should be to order a free copy of your credit report. You can get one from each of the three major credit bureaus and check them over, looking for incorrect information. If you find anything, report it to the agency in question. It then has 30 to 45 days to prove the information is correct or remove it from your credit report.
- Pay down existing debt. 30% of your credit score is based on how much you owe to creditors of all kinds.
- Make all your payments on time. Though it will take months to see results, this is the easiest way to raise your credit score.
- Take out a secured credit card. Let's say you want a spending limit of $1,000. You put $1,000 down on the secured card and borrow against those funds. Like a regular credit card, you make monthly payments that are reported to the credit bureaus.
You may be disappointed to have your mortgage application denied, but there's no reason to believe you're defeated. Addressing the root cause of loan denial is the surest way to get back out in the house hunt.
And when you're ready to try again, make sure to check out our guide on how to apply for a mortgage.
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