What happens if my mortgage application gets rejected?

So you’ve finally decided to purchase your first home, but you’ve hit a bump in the road and your home loan application was declined. What now?

Fortunately, a rejected home loan application doesn’t have to mean the end of your home buying journey. Below, we explore the reasons why your application might have been rejected and what you can do to get back on track.

Upon receiving your home loan application, lenders will want to see a comprehensive picture of your finances to make sure you’re able to pay it off over time. They look for red flags and establish your borrowing power based on the information you've given them. 

Here are some common reasons why your home loan application might be denied.

You have a bad credit history

For banks, your credit score is a measure of how reliable you are as a borrower. If you have bad credit, a mortgage lender might be reluctant to lend you the amount you want, or might even reject your application altogether.

You have a low deposit

While there are home loans available for borrowers with only 10% or even 5% deposit, having a deposit of less than 20% of a property’s value can sometimes pose a problem, especially if there’s little evidence you have genuine savings.

A home loan deposit establishes your financial stake in the home and lessens the financial risk of the lender, since you're covering more of the overall costs of the property. If your deposit isn't enough to meet the lender's requirements, you may risk falling into negative equity and not making your mortgage repayments.

There’s no evidence you can pay off a loan

Lenders will reject your application if your income isn’t enough to cover your regular mortgage repayments and day-to-day expenses. They will also add a buffer of around 3% to their advertised interest rate to determine if you can handle any rate hikes, called a serviceability test. 

You lack genuine savings

Banks like to see evidence of genuine savings: that is, funds that are a product of consistent savings habits over a period of time. If your entire deposit has been gifted to you, it won’t tell the bank anything about how financially disciplined you can be.

Banks will also want to know you can still set aside money regardless of whether you're making mortgage repayments or saving for a deposit, since this financial wiggle room reduces the risk you'll struggle with your repayments. After all, a lender wants borrowers who can definitely finance a home loan, not borrowers who can only sort of do it. 

The home loan structure is unsuitable

Your loan can be denied if your lender doesn’t think the type of home loan you’ve chosen is the right fit. For example, interest-only loans are riskier for banks because you’re not paying off the loan principal, so the lending criteria is often tighter.

It’s one thing to miss out on a home loan when you haven’t yet signed on the dotted line – you’ve still got plenty of time to improve your financial situation and try again. But what happens if you’ve already agreed to buy a property, but your lender rejected your home loan application?

If you’ve bought through a private treaty, there’s usually a cooling-off period of around five business days during which you can opt out of your contract (for a fee), or use the time before settlement to find another loan.

If you’ve bought at an auction, there’s no cooling off period so you’ll have to apply for another loan before settlement or risk losing your deposit. This is why having pre-approval is so important – it lets you limit your home buying search to properties you can reasonably afford.

If you've already got a mortgage, refinancing should be a sure thing, right? Unfortunately, that’s not always the case, especially these days when interested rates have shot through the roof.

If your personal circumstances (such as your employment or income) have changed, or banks’ lending criteria has gotten stricter since your first home loan application, you might run into some problems. When you refinance, you have to qualify for the home loan you're applying for, so if you've taken on more debt, lost income, or even had a kid since your first mortgage, you may have inadvertently become a home loan hostage. 

That goes doubly so if property prices have fallen and the home equity you hold has decreased. If you have negative equity (that is, your mortgage balance is greater than the current value of your home), lenders might be unwilling to take you on because your debt on your property is worth more than the property itself.

One good tip is to reduce your debt-to-income ratio by paying off any other debts you owe, such as car loans, personal loans, or credit cards. Paying down more of your home loan and reducing your LVR can also boost your approval chances, since the bank is lending you less of your home's overall value.

Rejections are hard, but you can always start afresh on a new home loan application once your circumstances have improved. Here are four steps to follow before re-applying. 

Don’t re-apply before you’re ready

Lenders reject loan applications because they have genuine reason to believe you can't service your loan. There’s no use in trying again with a different lender before you’ve made some necessary adjustments to your finances.

What’s more, every mortgage application you make will show up on your credit history as a 'hard enquiry', which may look unfavourable to potential lenders. Too many hard enquiries makes you look desperate for credit, and also suggest you've been rejected multiple times: a major lending red flag. 

Set up a budget

You’ll need to show a track record of genuine savings for your next home loan application, and drawing up a budget could be just the way to do that. If you can prove to mortgage lenders that you can live well within your means, your chances of approval may increase.

Know your borrowing power

If you’re looking to borrow more money than your current financial situation allows, you’re more likely to be rejected. Use a home loan borrowing calculator to see how much you might be able to borrow based on your current income and debts, and make sure to limit your search to properties within that range.

And don’t forget about all the extra costs associated with home ownership like home insurance, council fees, and utility bills. 

Clean up your credit

Another good strategy is to make sure that your credit report is in top shape. Start by requesting a free copy of your credit report from one of the three main credit reporting bodies (Equifax, Illion and Experian) and scan it for any mistakes. 

From there, it’s important you pay off any outstanding debts and keep a close eye on any bill payments to avoid late payment fees.

Lenders tend to look for applicants with higher credit ratings, because it means you'll be less likely to default on your home loan repayments. Low credit ratings are viewed as a financial risk to any lender, so work on bringing that number up.

Find yourself a great deal 

Once you've made sure your finances are in order and you’ve got the best chances at approval you can have, you could be ready to start looking at new loans. Browse our home loan comparison table for an idea of what’s currently available.