4 Reasons Your Refinance Application Can Be Denied
From insufficient collateral to a poor credit score, here are the most common reasons refinance applications are denied.
It's hardly a secret that the U.S. housing market is red-hot at the moment. In addition to mortgage applications soaring in response to historic low-interest rates, Americans are applying to refinance existing mortgages at record levels. By the end of 2020, refinance applications were up 120% over the previous year, according to a spokesperson for the Mortgage Bankers Association.
Although interest rates have been gradually climbing upward since February, they're still significantly lower than a year ago—meaning if you haven't jumped on the refinance bandwagon yet, it's not too late to do so. If you do plan to take advantage of low-interest rates, be sure to do your research in order to increase the odds of approval. A recent LendingTree report found that for the more than 2.8 million mortgage refinance applications in the nation's 50 largest metropolitan areas, about 17% were rejected.
The same report also identified the four most common reasons applications were denied: debt-to-income ratio was too high (26.5% of denied applications); lackluster credit history (23% of failed applicants); incomplete credit application (18.5% of unsuccessful applicants); insufficient collateral (14.9% of rejections).
Here's a closer look at each of these challenges and how you might avoid them when applying for a refinance of your mortgage.
1. Debt-to-Income Ratio
Your debt-to-income ratio is the percentage of your monthly gross income used to pay debts. If too large a chunk of your monthly earnings is drained by such payments, mortgage lenders are not likely to view your application favorably.
"Refinance lenders have gotten more cautious since the financial bubble; the lending standards are not as forgiving if you're stretching yourself too much," says LendingTree's Chief Economist Tendayi Kapfidze.
If this sounds like you, consider paying down or eliminating some debt altogether before seeking to refinance. In order to accomplish this, you might have to limit discretionary spending for a few months and be tougher with your household budget, redirecting money toward debt payments, says Kapfidze.
"Usually, you want to stay below a debt-to-income ratio of 43%," explains Kapfidze. "That would be the highest you could go. A more ideal number for debt to income would be under 36%. That's what a lot of lenders will prefer. Some won't do more than 36%."
2. Lackluster Credit History
Have you taken a look at your credit score lately? If you're contemplating refinancing, you might want to take a peek at where things stand because a less than ideal score or profile is the second most popular reason for rejection.
Lenders are looking for a score that is in the 700s, says Kapfidze. "If you don't have that, it doesn't mean you can't refinance," says Kapfidze. "But you might have to work harder to find a lender who will work with you."
There are several steps you can take to help improve your credit score before applying, adds Lauren Anastasio, CFP at SoFi. These include consistently keeping your overall debt load to a minimum, making on-time bill payments, and not opening new credit lines or closing credit lines, which can negatively impact your score.
"If someone has a low credit score and is looking to raise it quickly, paying down debts to lower overall utilization rate would be the most impactful step," says Anastasio. "Utilization rates should ideally be below 30%. Someone who is carrying high balances relative to their credit limits will see a significant boost by paying those cards or lines of credit down first."
Those who don't have significant credit history to show lenders or who have what Anastasio calls a "thin credit file" can often benefit by being added as an authorized user on a long-standing account belonging to a friend or family member. Being added to someone else's account, even if that account holder doesn't physically give you a credit card, means the history from that account will become part of your credit profile, often within as little as 60 days.
"As long as the account has been in good standing for a relatively long period of time, many young consumers or those who are older and looking to rebuild credit can see huge leaps in their credit score very quickly," says Anastasio. "It's likely the fastest way to boost someone's credit score."
3. Incomplete Application
This particular finding is likely tied to those who begin refinance applications, then abandon them for one reason or another. This is not uncommon, says Adrean Rudie, author of The Mortgage Loan Process.
"The number one thing I see people do to sabotage their success with a refinance is stop," says Rudie. "They simply stop the application at some point and go dark. Even in the very beginning, after they've put in their address and social security number, they never hit submit. Fear of failure? Shame or worry about credit? Overwhelmed by the process? Confusion on what it is that's being asked? All of the above. And most of the time they make it worse than it is in their mind out of fear."
If you're preparing to pursue a refinance, get all your required documentation organized ahead of time, and be sure to get it to the lender in a timely manner. Some of the best lenders will have staff members specifically designated to help walk you through all of the paperwork and documentation that's required.
4. Insufficient Collateral
Your house serves as the collateral when refinancing, and if the appraised value of the property comes in too low, it might cause your refinance application to be rejected by the lender. Lenders generally expect you to have a minimum of 20% in home equity in order to refinance. And if after an appraisal, it turns out that you owe more money than the home is currently worth, or you do not have 20% equity, the application will not pass muster.
"This can happen if your property value falls from when you initially purchased the home, or if you've used a home equity loan or line of credit, which has decreased your equity," says Anastasio. "This could also be a problem if you just haven't been in the home long enough to have paid down your principal balance enough."
Key Points to Remember When Refinancing
It's important to take the time to get your finances and documentation organized before starting a refinance application. Make sure to review your net worth, budget, and cash flow, and confirm that your debt-to-income ratio and credit score are in good order.
"Understand the things that lenders will be looking at," says Kapfidze. "And because everyone's situation is unique and different, one of the best things you can do to get the process started is talk to a lender or an expert to get a sense of what your refinance opportunities might be."
Remember, refinancing isn't always right for all homeowners, even amid low interest rates. It usually makes the most sense to proceed when you can reduce your interest rate by at least 1%, and you plan to stay in the home for at least a few more years so that you can recoup the expense of going through the process, says Brittney Castro, a CFP for Mint.
"You'll have to pay closing costs, which means you want to stay in the home long enough to recover those costs through your reduced monthly mortgage payments," says Castro.