Contact a real estate agent to start a home search and you are likely to be asked whether or not you’ve been pre-approved for a mortgage. Agents now suggest pre-approval as a matter of course. Getting pre-approved tells buyers what they can expect in terms of what they qualify for. This reduces the chances they will make an offer on a house they cannot afford.
Nonetheless, there are times when pre-approval ends with a mortgage ultimately being rejected. This leaves both buyer and seller in a lurch. There are workarounds but having to move on from a mortgage rejection is not easy.
City Home Collective is a Salt Lake City real estate brokerage and interior design firm with plenty of experience representing buyers and sellers. They say there are five main reasons pre-approved mortgages are ultimately rejected.
1. Insufficient Credit Score
Mortgage lenders take a very close look at a buyer’s credit score during the underwriting process. Not so much during pre-approval. If underwriting research indicates that a buyer’s credit score is not as high as required, the mortgage will be rejected. Understand that most lenders work from a baseline. Despite any extenuating circumstances, a credit score below that baseline is grounds for rejection.
2. Changes in Circumstances
There are times when a buyer’s circumstances change. For example, a buyer’s financial position might have been perfectly fine when pre-approval was given. But in the three months it took to find a house, the buyer was laid off. Now their financial position isn’t so rosy. The bank is not willing to take a risk until their employment situation is resolved.
3. High Debt-to-Income Ratio
Lenders take a good look at the difference between a buyer’s income and what they owe to other creditors. This is known as the debt-to-income ratio. If that ratio is too high, the mortgage might be rejected. And like other circumstantial changes, the buyer’s ratio could have been fine at the time of pre-approval but not so good when the underwriting process began. This is one of the reasons real estate brokers warn their clients to not take on any new debt while shopping for a home.
4. Insufficient Down Payment
Most pre-approval are offered with the understanding that buyers will make a predetermined down payment. Let’s say 10% for the sake of argument. If a buyer applies for a mortgage but only has 5% to put down, the smaller down payment could derail approval. Why? Because that’s akin to asking the bank to lend even more money.
5. Poor Appraisal Value
Banks insist that real estate is appraised well before closing on their mortgages. At the very least, a property must be appraised at a higher value than the mortgage. If not, no bank will take the risk. Loaning more money than a home is worth instantly puts the bank, and the homeowner, underwater.
Poor appraisal value is actually pretty common. A home will be listed at a certain price because that is what the current owner thinks it’s worth. A buyer might agree. But then a professional appraiser comes along and determines otherwise. This is exactly why banks require appraisals. They do not want to be stuck with a house that doesn’t cover the costs of the loan they made.
Getting pre-approval is essential in the modern housing market. Sellers look for it and buyers need it. But do not assume that pre-approval is the equivalent of a mortgage guarantee. Things might come up during the underwriting process. Any one of the five things explained in this post can turn a pre-approval into a flat-out rejection.