I want to buy a home, but where do I start?
Let's face it, as nice as it would be to buy a home without financing, it is simply not realistic for the majority of home buyers. If writing a check was all there was to it, purchasing a home would be fairly straightforward in regards to what is actually affordable. Throw in interest rates, several different loan products (all with different fees), different amortization periods, credit scores, mortgage insurance, and a few other variables for good measure, and the waters seem to be quite a bit more muddied. To what degree does the interest rate and amortization period affect my actual monthly payment? Can I find a low down payment loan with no mortgage insurance? How will my credit score affect what loans I can qualify for? All of these things affect how much home I can actually afford.
Welcome to the confusing maze that is financing a home purchase. With all of this in mind, one of the best investments to make in the quest of home ownership is meeting with a mortgage professional who can walk you through all of these questions and pre-approve you for a mortgage. Once armed with the knowledge of how much home fits into the immediate monthly budget and long-term goals, the muddy waters become clear again. It can very well be the difference between a stressful home search and a fun one!
What is a Pre-Approval, and why should I get one?
In simple terms, a pre-approval is a written commitment from a lender stating that a borrower qualifies for a certain loan amount and purchase price based off of income, asset, and credit documentation. A pre-approval is usually good for 60 to 90 days and involves a loan application, the reviewing of income documents, bank statements, and pulling credit.
Let's go beyond the basic definition of what a pre-approval is though. This is an opportunity to find out about all of the different options available to you as a buyer, and what loan programs would be best for any given situation. It is important to discuss financial goals and comfort levels to find what is truly the best fit. Based off of your profile strength, there may be several different options, such as getting rid of mortgage insurance up front, paying to lower the interest rate, and putting less money down on the home. Other options might include selecting a shorter amortization period and buying less home to keep the payments affordable. The goal is not to just get pre-approved, but to walk away knowing exactly what is affordable for you and fits into your budget. Just because you get approved for a certain dollar amount doesn't mean that it makes financial sense.
Having confidence in what price range fits in the budget is a great first step, but a pre-approval also gives you the added weight needed to have sellers and realtors take you more seriously. In today's market, realtors and sellers are very hesitant to enter into negotiations with a buyer who has not been pre-approved. In fact, some realtors will not even show a home unless they are presented with a pre-approval letter up front. If multiple offers have been made on a home, a seller will likely chose an offer backed by a pre-approval versus an offer without one. In essence, think of a pre-approval letter as a gate pass to get into the amusement park and check out all the rides.
What does the Pre-Approval process look like?
The first step in any pre-approval is to complete a loan application with a loan officer. The loan officer's application is called a 1003 and asks basic questions about residence history, job history, asset and income history, and credit questions. This step can either be completed in a face-to-face meeting or over the phone, but this application should really only take about 15-20 minutes to complete.
After completing the loan application, the loan officer will want to pull credit to look at what range your credit scores are at. When getting pre-approved for a mortgage, lenders will pull scores from three different bureaus and use the middle score to determine what kind of interest rates and programs are available. Because of this, it is important to stay up to date on what your credit scores look like. If one score is high, but the other two have dropped, you could be in a rough position come qualifying time.
To verify that the information provided in the loan application is correct, the loan officer will also want to review your income and asset documentation. As a general rule of thumb, they will want to see two years of W2s and tax returns as well as your two most recent pay stubs. They will also want to see sixty days of bank statements to verify that there is enough funds to take care of a down payment and closing fees.
Once the loan officer has taken a loan application and verified income, assets, and credit scores, he or she will run the scenario through an automated underwriting program to make sure the loan fits within a lender's guidelines. At this point, a decision can be made about your pre-approval.
What if I can't get a Pre-Approval?
There are three main reasons that a pre-approval denial could occur. If you fall into one of these catagories, don't be afraid to ask your loan officer for tips to improve your chances of getting pre-approved.
1. Credit Report - Either the scores on the credit report are too low, or there could be a bankruptcy, foreclosure, or short sale showing in the history of the report. Typically, borrowers have to wait a certain period of time after one of these events before they can qualify for another loan. Talk to your loan officer to see if they can recommend a credit repair specialist to help improve your credit score. In many cases, an improvement in the score can be seen in as little as 60-90 days, and in some cases, as soon as 30 days.
2. Debt-to-Income Rate - This ratio measures what percentage of your monthly gross income goes toward debt payments. Debt payments would be classified as monthly housing expenses like rent or a mortgage payment, car payments, credit card minimum payments, student loans, and other installment loans. If this ratio is too high, it could prevent you from getting a pre-approval on a loan. The typical solution to this problem is to lower your overall debt. This can take time depending on the situation.
3. Down Payment - Lenders typically have minimum down payment requirement that must be met in order to provide financing on a home purchase. Higher down payments can also prevent loans from having mortgage insurance and lower the total monthly payment leading to a lower debt-to-income ratio.
If you cannot get a pre-approval now, don't give up on your dream of home ownership. Your loan officer should be able to help you come up with a game plan to get pre-approved in the future. What is important is knowing where you stand and what actions are needed. With a little planning and preparation, a pre-approval should be doable in the near future.