Higher mortgage rates push application denial rates up: St. Louis Fed

Higher interest rates do more than just deter potential homebuyers — they may also block consumers from qualifying for a mortgage, according to new research.

The rate of denials in loan applications was 15.1% in 2024, up from 12.2% in 2021, a rise that occurred alongside a surge in mortgage rates from below 3.5% to more than 6.5%, researchers at the Federal Reserve Bank of St. Louis said in a new blog post.

At the same time, however, fewer consumers were applying for mortgages as rates peaked at 8% in 2023, the research shows. Total applications fell to 3.5 million that year — when the denial rate was 15.7% — from more than 5.2 million in 2021. The St. Louis Fed researchers used data covering more than 30 million home purchase applications.

With the current average rate on a 30-year fixed-rate mortgage at 6.61% as of Wednesday, according to Mortgage News Daily, affordability issues have changed little from the time period examined in the research, experts say.

“The dynamics are the same,” said Jessica Lautz, deputy chief economist and vice president of research for the National Association of Realtors, a trade association for real estate professionals. “I would say the pressures that the bottom half of the K-shaped economy was feeling are still there.”

The median price of an existing home in the U.S. was $417,700 in April, up a modest 0.9% from $414,000 a year earlier, according to the National Association of Realtors. However, that figure is about 22% higher than in April 2021, when it was $341,600, and 45.6% above the April 2020 median price of $286,800.

One reason for the rise in mortgage application denials at higher interest rates is that the borrower’s debt-to-income ratio is coming in too high, according to the St. Louis Fed research. Lenders use that ratio to measure how much of a borrower’s income will be eaten up by debt payments each month, including a proposed mortgage payment.

“When rates rise, the entire distribution of debt-to-income ratios shifts to the right, pushing a larger share of the applicant pool above the hard thresholds where lenders start saying ‘no,'” the researchers wrote. “Rising rates don’t just price people out of the houses they want; they lock people out of the credit they need.”

Lenders prefer to see that ratio at 36% or below, but depending on other factors — including credit history, assets and income — they may approve an applicant whose debt-to-income ratio is higher, experts say.

However, for many lenders that do conventional mortgages, there’s a hard cut-off at a 50% ratio, according to experts.

The Fed research cited buyers’ debt-to-income ratio as the primary reason for a rejection in 35% of mortgage denials in 2024, up from 29% in 2018. The data showed the denials happened across credit scores, Carlos Garriga, director of economic research at the Federal Reserve Bank of St. Louis and one of the researchers, said in an email to CNBC.

“Even applicants in the highest credit quartile face a sudden, clean four-percentage point jump in rejections the moment their arithmetic touches [above 50%] DTI,” Garriga said. He pointed to Fannie Mae’s underwriting software as a reason for that cliff. 

“Pristine credit or a six-figure income cannot override a blunt software gate that looks only at a binary financial ratio,” Garriga said.

Fannie Mae, a government-sponsored enterprise, is the largest purchaser of mortgages on the secondary market — which means its guidelines are followed by lenders that want the agency to purchase their mortgages. Most do, because it provides capital to originate more loans. Fannie bundles the loans it buys and sells them to investors as mortgage-backed securities.

Some lenders also use Freddie Mac, another GSE and mortgage purchaser, to qualify applicants. Freddie does not have the hard 50% cutoff in its automated underwriting system, Garriga said.

On top of rates and home prices that have been persistently higher than they were five years ago, student loan debt often contributes to the debt-to-income ratio for first-time homebuyers, said the NAR’s Lautz. It is “typically one of the biggest hurdles for young adults to qualify for a mortgage,” she said.

“There’s a ton of pent-up demand. We have a huge share of young adults who would like to come into the housing market,” Lautz said.