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Higher interest rates aren’t just deterring potential homebuyers — they can also deter consumers from qualifying for a mortgage, according to a new study.
The loan application denial rate was 15.1% in 2024, up from 12.2% in 2021, an increase that coincided with a jump in mortgage rates from under 3.5% to over 6.5%, researchers at the Federal Reserve Bank of St. Louis said in a new blog post.
But at the same time, fewer consumers were applying for mortgages as interest rates peaked at 8% in 2023, the study shows. The total number of applications fell to 3.5 million this year from more than 5.2 million in 2021 – when the rejection rate was 15.7%. St. Louis Fed researchers used data from more than 30 million home purchase applications.
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With the current average interest rate for a 30-year fixed-rate mortgage at 6.61% as of Wednesday, according to Mortgage News Daily, affordability issues have changed little since the period examined in the study, experts say.
“The dynamic is the same,” said Jessica Lautz, deputy chief economist and vice president of research at the National Association of Realtors, a trade association for real estate professionals. “I would say that the pressure felt by the bottom half of the K-shaped economy is still there.”
Affordability fell in April
According to the Mortgage Bankers Association, a trade group for mortgage lenders, affordability fell in April as the median payment required of mortgage applicants rose to $2,152 from $2,131 in March.
According to the National Association of Realtors, the median price of an existing home in the U.S. was $417,700 in April, a modest 0.9% increase from $414,000 a year earlier. However, this value is approximately 22% higher than April 2021, when it was $341,600, and 45.6% higher than the April 2020 average price of $286,800.
One reason mortgage application rejections increase with higher interest rates is that the borrower’s debt-to-income ratio is too high, according to a study by the St. Louis Fed. Lenders use this ratio to measure how much of a borrower’s income is eaten up by debt payments each month, including a scheduled mortgage payment.
“As interest rates rise, the entire distribution of debt-to-income ratios shifts to the right, causing a larger proportion of the applicant pool to pass the hard thresholds at which lenders begin to say ‘no,'” the researchers write. “Rising interest rates not only deprive people of the homes they want, they also deprive them of the credit they need.”
Lenders prefer to see that ratio at 36% or lower, 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 who issue conventional mortgages, experts say there is a hard limit of 50%.
A high debt-to-income ratio accounts for 35% of rejections
The Fed’s study cited buyers’ debt-to-income ratios as the primary reason for denial in 35% of mortgage denials in 2024, up from 29% in 2018. The data showed the denials occurred across all 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, significant four percentage point increase in rejections as soon as their arithmetic score becomes significant [above 50%] “DTI,” Garriga said. He pointed to Fannie Mae’s underwriting software as the reason for this cliff.
“A flawless credit score or a six-figure income cannot override a blunt software gate that only looks at a binary financial metric,” Garriga said.
“There is a lot of pent-up demand. We have a large proportion of young adults who would like to enter the housing market.”
Jessica Lautz
Deputy Chief Economist and Vice President of Research for the National Association of Realtors
Fannie Mae, a government-sponsored corporation, is the largest buyer of mortgages in the secondary market — meaning its policies are followed by lenders who want the agency to buy their mortgages. Most do this because it provides capital to make additional loans. Fannie pools the loans it buys and sells them to investors as mortgage-backed securities.
Some lenders also use Freddie Mac, another GSE and mortgage buyer, to qualify applicants. According to Garriga, Freddie doesn’t have the strict 50 percent limit in its automated underwriting system.
In addition to interest rates and home prices consistently higher than they were five years ago, student loan debt often contributes to the debt-to-income ratios of first-time homebuyers, NAR’s Lautz said. It’s “typically one of the biggest hurdles for young adults to qualify for a mortgage,” she said.
“There is a lot of pent-up demand. We have a large proportion of young adults who would like to enter the housing market,” said Lautz.
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