Picture this: You’re driving through your favorite neighborhood and you suddenly see a sign on a home that says ‘For Sale’. Your mind is flooded with the possibilities of having a life that you always dreamed of. But as exciting as shopping for a new home can be, the thought of buying property is always accompanies with the fear that you may not get approved for a mortgage loan.
To make matters worse, a study shows that almost one in three mortgage applicants –that’s a whopping 32 per cent! – face rejection from lenders due to low-credit-profile. This recent figure is much higher than previously known through the Observed Denial Rate which quoted a rejection risk of just 11 per cent, obviously not taking into account the shifting credit profiles of mortgage applicants.
Real Denial Rate
The latest research conducted by the Urban Institute’s Housing Finance Policy Center (HFPC) reveals shocking data on the number of mortgage applicants whose loan applications were rejected last year.
The researchers used data that was publically available as well as figures from CoreLogic to come up with a Real Denial Rate (RDR) for mortgage applications. In comparison, the Observed Denial Rate (ODR) is often calculated through the date released by the government in accordance with the Home Mortgage Disclosure Act.
To make the ODR more precise, HFPC decided to adjust for applicants’ changing credit profiles which gave a more precise calculation of the real mortgage rejection rate. Unlike the 11 per cent figure suggested by the ODR, the researchers found that the Real Denial Rate climbs up to 52 per cent for mortgage applications below $70,000 (also known as small-dollar loans).
Most potential homeowners apply for a cheaper mortgage thinking that it’ll increase their chances of getting accepted but in reality, the situation is quite different. HFPC says that non-government channels often overstate the small-dollar loans’ acceptance rates but their investigation has found them to have high RDR due to the fixed costs associates with such loans which make them less desirable for banks.
Factors Affecting Mortgage Acceptance Rate
The data from research showed that applicants with low-credit-profiles didn’t limit their mortgage applications to small loans. Only 34 per cent of the low-credit applicants applied for small-dollar mortgages whereas the remaining opted for loans greater than $150,000.
The new data is quite scary for those who wish to become homeowners in the future. At the time of applying for a mortgage, the Housing Finance Policy creates a complete financial profile of the borrower which includes their credit score, debt-to-income ratio, loan-to-value ratio, the type of mortgage they choose and documentation choice for the new home.
The HFPC research looked into all the factors in the applicants’ mortgage profile and found out that those who had a credit score of over 700 points, a debt-to-income ratio of 30 per cent or less and a loan-to-value ratio of below 78 per cent were more likely to be accepted for the loan. The loan-to-value ratio shows that applicants with a strong chance of getting a mortgage put down more than 22 per cent in down-payment which is slightly higher than the recommended 20 per cent.
Strong applicants also propose 30 per cent or less of their average income for mortgage payments which is considered a standard figure for affordability.
Importance of High Credit Score
The main purpose of the research was to show the importance of credit score in getting your loan application approved. Most people fail to understand the different factors that make up their credit score, and even though most critics argue that this metrics isn’t the best way to asses a borrower’s credit worthiness, banks still heavily rely on individuals’ credit score before making any lending decisions.
When applying for a mortgage, remember that your credit score probably matters more than all other metrics combined which is why it is absolutely essential that you keep an eye on it and find ways to improve it before submitting your loan application.
There are a number of free apps and services that monitor your credit score and send your warning notifications if it starts to drop too low. You can also use a number of online resources to learn how to improve your credit score in order to lower your mortgage rejection risk.