The Impact of Rising Interest Rates on Mortgage Borrowing

This is the first in a series of four blog posts that explore the challenges potential homebuyers face when seeking a mortgage loan.

The standard story about how interest rate hikes cool the housing market is merely about their effect on demand: Higher rates make mortgages more expensive, so fewer people want to buy. But our research reveals a second and more prevalent channel that operates on the supply side of credit. Higher rates don’t just discourage borrowers; they also disqualify them because of the regulatory wall. Applicants with stable incomes, steady employment and no change in their financial profile can fail to meet underwriting thresholds simply because the prevailing interest rate increased their projected monthly payment.

Using publicly available Home Mortgage Disclosure Act (HMDA) data covering more than 30 million home purchase applications from 2018 to 2024, we find that the increase in mortgage interest rates during the Federal Reserve’s 2022-23 tightening cycle can account for the entirety of the rise in aggregate denial rates. The mechanism is straightforward arithmetic, and the implications for how monetary policy operates through this channel are quite significant.

The Arithmetic of Disqualification

When a lender evaluates a mortgage application, the single most important metric is the debt-to-income ratio—the share of a borrower’s monthly income assigned to service the debt including the interest payment and the amortization of the principal. This ratio is the No. 1 reason lenders cite when rejecting an application, accounting for 35% of all denials in 2024, ahead of credit history, collateral and every other factor reported in the HMDA. A high ratio signals that the borrower’s income leaves too little margin for error, and lenders treat it as a hard constraint.

Here’s the connection with the transmission mechanism of monetary policy: The debt-to-income ratio depends directly on the interest rate. Consider a borrower earning $6,000 per month with $500 in existing debt who applies for a $400,000 mortgage. At a 3% interest rate (roughly the market rate in 2021), the monthly mortgage payment is about $1,686, producing a ratio of 36%. At 7% (closer to 2023 rates), that same loan costs $2,661 per month, pushing the ratio to nearly 53%. The borrower’s income didn’t change. The borrower’s debts didn’t change. But the interest rate alone moved that person from an affordable position to an uncomfortable one that most lenders would reject.

This isn’t a marginal case. 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.” Rising rates don’t just price people out of the houses they want; they lock people out of the credit they need.

The Data Confirm Synchronization between Denial Rates and Interest Rates

The table below illustrates the close synchronization between denial rates and interest rates over our sample period. As the median contract rate on originated mortgages fell below 3.5% during 2020-21, the denial rate dropped to 12.2% in 2021. When rates climbed above 6.5% during 2022-23, the denial rate rose to 15.7% in 2023, meaning nearly 1 in 6 applications were rejected. This increase is especially striking because far fewer people were applying: Total applications fell from over 5.2 million in 2021 to 3.5 million by 2023. If anything, the borrowers still entering the market should have been stronger candidates, since those with weaker credit profiles presumably self-selected out. Yet denial rates rose anyway, suggesting that higher rates were disqualifying applicants who would have been approved just two years earlier.

To quantify how much of this increase was driven by rates, we estimated the sensitivity of denial rates to interest rates using a regression that controls for borrower characteristics and state-level differences, then multiplied that sensitivity by the observed 3.62 percentage point increase in the median rate of originated mortgages between 2021 and 2024.

The result: The rate increase alone can account for 100% of the rise in the aggregate denial rate. In the aggregate, the cost of capital, not a deterioration in borrower quality, was the dominant force.

The Smoking Gun: What Lenders Tell Us about Denials

The shift in why lenders deny applications provides direct evidence for this channel. In 2018, the debt-to-income ratio was cited as the primary reason for rejection in 29% of denials, running roughly neck and neck with credit history. By 2024, this ratio had pulled ahead to 35%, making it the single largest category, while credit history held steady at 29%.

This shift is exactly what the disqualification channel predicts. Borrowers weren’t developing worse credit histories during the tightening cycle, and their incomes weren’t falling. What changed was the arithmetic: Higher rates drove higher projected payments, which spiked debt-to-income ratios and triggered more denials. Lenders’ own stated reasons confirm that the mechanism runs through affordability, not creditworthiness.

Demand Reduction vs. Credit Rationing

Demand reduction occurs when potential homebuyers look at higher interest rates and decide a mortgage is too expensive, so they choose to step away. In contrast, credit rationing happens because lenders face private information constraints—they cannot perfectly know who will default. To protect themselves, lenders use tools like FICO scores and tightening lending standards to limit who gets a loan. So, while a buyer might be perfectly willing to pay the higher market interest rate, credit rationing means the lender steps in and says “no.”

The distinction between discouraging borrowers and disqualifying them is worth keeping in mind, because it can alter how we view the broader effects of higher interest rates.

When interest rates deter a prospective buyer from entering the market, that household retains the option to buy later when conditions improve. But when rates push an applicant past a debt-to-income threshold, the result is a formal denial on the person’s record, a rejection that can affect future applications and that represents a harder barrier than simply choosing to wait.

Moreover, the disqualification channel is not uniform. Borrowers who were already near underwriting thresholds (those with moderate incomes or higher existing debts, or those who are purchasing in high-cost markets) are the ones most likely to be pushed over the edge of the regulatory constraint. A rate hike of identical magnitude is irrelevant to a borrower with a debt-to-income ratio of 25% but devastating to one at 48%. This means that tightening cycles don’t just reduce the volume of homebuying; they selectively filter out the most financially constrained applicants.

As we explore in the series’ next blog post, the specific debt-to-income threshold where this filtering kicks in is not where most people, or regulators, think it is.

Notes

1. This post is based on our St. Louis Fed working paper “The Determinants of Mortgage Denial Using Public Data,” April 29, 2026.
2. Our series also includes an upcoming post about the specific challenges facing first-time homebuyers and another on why cheaper houses are tougher to finance.