Homebuyers Face Setback: Mortgage Applications Denied Over Income Shortages

The housing bubble is heating up, with median 30-year mortgage rates hitting the 8% threshold, the highest since 1995. As monthly mortgage payments rise because of soaring home prices and interest rates, obtaining a mortgage has become increasingly challenging for many prospective buyers.

Unsurprisingly, total application volume fell by 6.9% week-over-week as of Oct.18, 2023, according to data released by the Mortgage Bankers Association's seasonally adjusted index. 

As mortgage rates rose in tandem with rising overnight federal funds rates, more loan applications are being denied, citing insufficient funds or income as the primary reason. A recent report from the Consumer Financial Protection Bureau (CFPB) stated that loan applications were denied on the grounds of insufficient income more frequently than at any other time in 2022 since records began in 2018.

Approximately 9.1% of all home purchase applications were declined in 2022, an 800-basis-point rise from 8.3% in 2021. In the case of refinance applications, the rejection rate saw a significant jump, reaching 24.7% in 2022, compared to 14.2% in 2021.

"Both purchase and refinance applications declined, driven by larger drops for conventional applications," said Joel Kan, vice president and deputy chief economist at the Mortgage Bankers Association. 

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Rising Mortgage Payments 

The average monthly mortgage payment saw a substantial 46% rise, reaching $2,045 in December 2022, compared to $1,400 in December 2021. This, coupled with rising mortgage rates and increasing rejections, has caused investors to pull back on new purchase and refinance applications. 

"I think people are feeling squeezed on all sides," Bankrate's senior industry analyst Ted Rossman said. "It's really a double whammy, especially for first-time buyers who don't have any equity that they can trade in."

Housing prices and mortgage rates have risen exponentially more than median wages, causing consumers to take on additional debt to meet their household expenses. 

"In most cases, income did not increase at the pace of average mortgage payments," Barry Glassman, founder and president of Glassman Wealth Services, said. 

Improve Credit Score 

The increased rates of mortgage denials based on income can also be attributed to the surging overall debt levels of consumers. 

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The 28/36 rule is a common standard in the housing sector, used by mortgage lenders to assess the proportion of median income consumed by housing expenses and other debts. Lenders typically seek applicants who allocate no more than 28% of their gross income to housing costs. 

Ideally, mortgage, property taxes and insurance should represent less than 28% of gross monthly income; overall debt, encompassing mortgage, credit card balances and auto loans, should not surpass 36%.

The median credit score for individuals seeking loan refinances is now lower than the median credit score for those applying for home purchase loans, marking a reversal of a recent trend, as reported by the CFPB.

"And from a credit scoring standpoint, too, that's another big part of this whole discussion," said Rossman. 

Effectively managing debt levels is paramount when applying for a new mortgage, especially for first-time home buyers. Not only do consumers with a good credit score have a lower chance of mortgage application refusal, but they also enjoy lower mortgage rates. 

"The difference between a 575 FICO score and a 675 FICO score could be as much as 1% on your mortgage rate," Ted Jenkin, CEO of oXYGen Financial, said.

An applicant with a debt-to-income ratio of over 40% faces a higher probability of rejection and is also charged higher rates. If cumulative monthly debt, including payments for auto loans, student loans and mortgages, exceeds 40% of total monthly income, the likelihood of facing a loan denial increases.

Most lenders require a minimum score of 600, or possibly as high as 660, to qualify for a mortgage. Achieving a score of 760 or higher allows applicants to secure the most competitive interest rates available in the market.

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