As mortgage rates rise and home prices remain high, many potential homebuyers are finding it increasingly difficult to secure financing. A recent report from the Consumer Financial Protection Bureau (CFPB) reveals that “insufficient income” is now the leading cause of mortgage application rejections, marking a notable trend in the housing market.
Rising Mortgage Payments and Rejections
In 2022, nearly a quarter of refinance applications were denied—up sharply from 14.2% the previous year. Among all home purchase applicants, 9.1% had their applications rejected, slightly higher than the 8.3% in 2021. This is a reflection of the overall tightening in the housing market. The main reason cited for these rejections was insufficient income to afford the higher costs associated with homeownership.
The average monthly mortgage payment in December 2022 soared to $2,045, a staggering 46% increase from $1,400 in December 2021. This sharp increase is largely attributed to the Federal Reserve’s rate hikes, which have driven up mortgage rates, making monthly payments more unaffordable for many buyers.
The Strain on Consumers
Ted Rossman, a senior industry analyst at Bankrate, points out that it’s a “double whammy” for first-time buyers. They are particularly vulnerable because they don’t have equity from previous homes to leverage, and they face both rising home prices and higher interest rates. Consumers are also under pressure due to rising inflation, which has led to increased debt levels. Many are now struggling to keep up with their housing costs, which lenders typically expect to represent no more than 28% of a borrower’s gross monthly income, as part of the 28/36 rule.
This means that for many applicants, their debt-to-income (DTI) ratio exceeds the threshold that lenders are comfortable with. If an applicant’s monthly debt payments—combining auto loans, student loans, and mortgage payments—add up to more than 40% of their total income, their chances of mortgage approval decrease significantly.
The Importance of Debt-to-Income Ratio (DTI)
Certified financial planner Ted Jenkin emphasizes the significance of the DTI ratio in today’s housing market. He advises consumers to focus on keeping their DTI as low as possible before applying for a mortgage. Higher DTI ratios, currently more common among Hispanic and white applicants, indicate to lenders that the applicant may struggle to handle additional debt, increasing the likelihood of rejection.
“People are feeling squeezed on all sides,” says Rossman, noting that rising credit card debt and other liabilities are contributing to these challenges. Additionally, the CFPB’s data suggests that a borrower’s credit score can also play a crucial role in securing a mortgage. With lenders placing higher scrutiny on credit scores, many applicants find that their FICO scores no longer meet the standards required to qualify for favorable loan terms.
Credit Scores and Their Impact
According to Jenkin, the difference between a FICO score of 575 and 675 can mean a substantial increase in the mortgage interest rate, potentially as much as 1%. For many, this increase in rates can push them into the category of having insufficient income, as they will face higher monthly payments.
With the median credit score for refinance applicants now lower than for home purchase loans, applicants are encouraged to closely monitor and manage their credit scores. The FICO scoring model ranges from 300 to 850, and a higher score means a better chance of securing favorable loan terms and lower interest rates.
What Consumers Can Do
To improve their chances of mortgage approval, consumers should aim to reduce their overall debt load, avoid taking on additional liabilities, and work to improve their credit scores. Being aware of how much house they can afford based on their income and debt-to-income ratio is crucial before applying for a mortgage.
In the current environment, first-time homebuyers face an uphill battle, with rising rates and home prices putting homeownership out of reach for many. The key to successfully navigating this market is understanding and managing your financial profile, especially DTI and credit score, to ensure that you can meet lenders’ requirements.
For those struggling to meet the financial criteria, it may be necessary to adjust expectations or delay purchasing a home until their financial situation improves.