How to Get a Mortgage Pre-approval
The journey of home shopping frequently commences at a lender's office, where prospective buyers submit their mortgage applications, rather than at an open house. It has become increasingly common for sellers to anticipate that buyers will secure pre-approval for financing before engaging in negotiations. Sellers are often more inclined to enter into discussions with individuals who demonstrate their ability to obtain a loan.
Some loan options cater specifically to low- to moderate-income homebuyers or first-time buyers. Additionally, loans such as Veterans Affairs (VA) loans, which do not require a down payment, are available exclusively to U.S. veterans and service members.
Distinguishing Pre-Qualification from Pre-Approval
While a mortgage pre-qualification can offer a rough estimate of an individual's affordability when purchasing a home, a pre-approval holds greater value. Typically valid for a period of 60 to 90 days, a pre-approval entails the lender conducting a thorough assessment of the buyer's credit, verifying assets, and confirming employment in order to approve a specific loan amount.
Buyers can greatly benefit from engaging in discussions with a lender, obtaining a pre-approval letter, and exploring loan options while considering their budget. With the lender providing the maximum loan amount, buyers can establish a realistic price range for their home search. To assist with estimating costs, buyers may also utilize a mortgage calculator.
Prerequisites for Obtaining Pre-Approval
To obtain mortgage pre-approval, buyers must fulfill certain requirements, including completing a comprehensive mortgage application and providing substantiation of assets, income verification, good credit history, proof of employment, and essential documentation.
The pre-approval process takes into account factors such as the buyer's FICO credit score, debt-to-income ratio (DTI), and other relevant criteria depending on the type of loan being pursued.
With the exception of jumbo loans, all loans adhere to the guidelines set by Fannie Mae and Freddie Mac.
Verification of Income
Prospective homebuyers are required to provide various documents as proof of income. This includes W-2 wage statements and tax returns from the previous two years, current pay stubs indicating both regular income and year-to-date earnings, as well as evidence of additional income sources such as alimony or bonuses.
Confirmation of Assets
To demonstrate financial capability, borrowers must furnish bank and investment account statements showing sufficient funds for the required down payment, closing costs, and cash reserves. The down payment, expressed as a percentage of the property's selling price, varies depending on the type of loan. For many loans, if the buyer is unable to put down at least 20% of the purchase price, they may be required to purchase private mortgage insurance (PMI).
Creditworthiness
Most lenders impose certain credit score criteria for loan approval, typically requiring a FICO score of 620 or higher for a conventional loan and 580 for a Federal Housing Administration (FHA) loan. Customers with a credit score of 760 or higher often receive the most favorable interest rates.
The Consumer Financial Protection Bureau provides an interest rate tool that enables buyers to assess how their credit score, loan type, home price, and down payment amount can impact the interest rate. For instance, on a $250,000 loan, an individual with a FICO score in the lowest range (620–639) would make monthly payments of $1,288, while a homeowner in the highest range (760–850) would pay only $1,062, resulting in a yearly difference of $2,712.
Verification of Employment
In addition to reviewing pay stubs, lenders go the extra mile to verify a buyer's employment by contacting the employer directly to confirm the borrower's current employment status and salary. For self-employed individuals, additional information is required to assess the stability of their income. This may include details regarding the nature and location of the business, the financial strength of the business, and its ability to consistently generate enough income to support the borrower's mortgage payments.
Final loan approval is granted when an appraisal of the property is conducted and the loan is applied to the designated property.
Submission of Relevant Documents
As part of the pre-approval process, borrowers are expected to provide certain personal documents and identification. These typically include a valid driver's license, a Social Security number, and authorization for the lender to obtain a credit report. By diligently submitting all the necessary documentation, borrowers can streamline the pre-approval process and enhance their chances of obtaining a favorable loan.
Distinguishing Pre-Approval from Approval
Within three business days of receiving a complete mortgage application, the lender is obligated to furnish a loan estimate, a crucial document that outlines various details. These include the pre-approved loan amount, maximum loan amount, mortgage terms and type, interest rate, estimated interest and payments, projected closing costs, property tax estimates, and homeowner's insurance information.
The loan file subsequently transitions to a loan underwriter, who assesses the borrower's adherence to specific loan program guidelines for full approval. If the buyer's financial situation remains unchanged since pre-approval, both the buyer and lender can proceed with the loan closing process.
What Happens If You're Not Pre-Approved?
After reviewing a mortgage application, the lender will provide a decision that may include pre-approval, denial, or pre-approval with conditions. If conditions are attached, the borrower may need to submit additional documentation or reduce existing debt to meet the lender's guidelines. In the case of denial, the lender should provide an explanation and suggest options for improving the borrower's chances of pre-approval.
When Should You Get Pre-Approved for a Mortgage?
Obtaining pre-approval for a mortgage is recommended before commencing the house-hunting process. Doing so helps determine the maximum loan approval amount and identifies any obstacles, such as excessive debt or suboptimal credit scores.
Why is Pre-Approval Important?
Having mortgage pre-approval gives homebuyers a significant advantage as it provides them with bargaining power. With pre-approved financing already secured, buyers can make reasonable offers to sellers on properties of interest. Otherwise, potential buyers would need to apply for a mortgage before making an offer, potentially missing out on bidding opportunities.
Understanding Loan-to-Value (LTV) Ratio
The loan-to-value (LTV) ratio is a measure of lending risk that financial institutions and lenders evaluate before approving a mortgage. It compares the loan value to the market value of the property. Generally, loans with higher LTV ratios are considered higher-risk, resulting in potentially higher interest rates if the mortgage is approved.
Exploring Debt-to-Income (DTI) Ratio
The debt-to-income (DTI) ratio represents the percentage of a person's gross monthly income allocated towards monthly debt payments. Lenders utilize this ratio to assess a borrower's risk profile when considering loan applications.
In Conclusion
Mortgage pre-approval involves a comprehensive evaluation of a homebuyer's financial situation, with lenders requiring five key elements to ensure borrowers have the capacity to repay their loans. Prospective borrowers complete a mortgage application and provide proof of assets, income verification, credit reports, employment confirmation, and other essential documentation to secure pre-approval.