So you’ve finally found the home of your dreams. It has everything you ever want, but the seller wants something from you: Proof your eyes aren’t bigger than your bank account!
It comes in the form of a mortgage pre-approval. To which a lot of people say, “A mortgage pre-a-what?”
If you’re wondering what a pre-approved mortgage is, what one costs and where you can get one, please read on.
What is a Mortgage Pre-Approval?
Pre-approval for a mortgage is validation to the seller that you are a legitimate buyer. A lender evaluates your finances and determines whether you are qualified to borrow the amount you’ll need for a mortgage.
If you are, you’ll get a letter attesting to that fact. A pre-approval is a good idea for a number of reasons.
Unless you’re paying cash (in which case you don’t even need to be reading this), you’re going to have to jump through all the mortgage hoops anyway. You might as well start the process early, find out if you have any red flags and begin exploring financing options.
If sellers are getting multiple offers or inquiries about their house, pre-approval will secure you a favored place in the pecking order.
“The pre-approval is important as it confirms that a buyer is serious about the home buying process and has the financial capability to purchase a home at a certain price for all the stakeholders in the potential transaction,” said Arden Czyzewski, a loan originator with The Mortgage Firm
Difference Between Pre-Qualification and Pre-approval
Pre-qualification is an informal process where a lender asks about your income, assets and liabilities. Then they estimate how much money you can borrow. It’s really just a useful guide that lets you know about how much you could borrow for a house. There’s no sense shopping for mansions when you have a condo budget.
The pre-qualification amount is not a solid number, however. It’s just estimate based information that hasn’t been verified, so it doesn’t carry the same weight as pre-approval.
How Much Mortgage Can I Get Approved For?
Your loan potential is largely based on two basic financial components. How much you make and how much you already owe.
The industry term for this is debt-to-income ratio, or DTI. It’s calculated by taking your total recurring monthly debt load (mortgage/rent, car loan, student loan, minimum payment on credit cards) and dividing it by your gross monthly income.
Say you make $5,000 a month in take-home pay and you spend $700 a month on rent; $500 a month on an auto loan; $200 a month on a student loan; and $300 a month on credit cards.
You have $1,700 a month in debt compared to $5,000 in revenue, so your DTI is 34%. That could be troublesome if you replace the rent payment with a $1,000 mortgage payment. That would push your debt-to-income ratio up to 40%.
Most lenders want a client’s DTI to not exceed 36%, so you could add only an $800-per-month mortgage (including homeowner’s insurance, property taxes and private mortgage insurance) and stay below the 36% DTI threshold.
That number is not written in stone, however. Credit scores also weigh heavily in the calculation, so it’s a good idea to check your credit reports beforehand to make sure they are accurate. Scores range from 300 to 850. The higher your score, the lower the interest rate will be on your loan. Knowing your credit profile and the lender’s requirements will help you understand what kind of interest rate you qualify for.
Can I Get a Mortgage Pre-Approval Online?
Yes, you can get a pre-approved for a home loan with an online lender like Quicken, SoFi or Loan Depot.
Any lending institution that handles mortgages should be able to provide pre-approval. That includes banks, credit unions and the growing industry of online lenders.
A 2017 report by Mortgage Daily found that 47% of all mortgages in the fourth quarter of 2016 originated at “non-bank” lending institutions like Quicken, Lending Tree, SoFi and Loan Depot.
The Internet has also streamlined a process that used to take days or even weeks to complete. Now even traditional lenders like banks allow you fill out forms online to get the ball rolling.
It’s a buyer’s market, so if you are open to offers, just fill out an online form and lenders will be emailing and calling you before you have time to use the bathroom.
What Documents You Need to Provide
The pre-approval process isn’t as involved as a formal loan application to get a mortgage, which requires extensive documentation like income tax returns, driver’s license, pay stubs, insurance forms, home owners association documents, mortgage statements, divorce records, Social Security record and bank statements.
Unfortunately, such busy work is just one of those hassles you have to accept if you want somebody to lend you hundreds of thousands of dollars.
The hassle isn’t usually as bad with pre-approval. A lot depends on your financial situation and how much you are seeking to borrow. A loan officer will ask preliminary questions about your income and debts. They investigate your credit report and typically need documentation of employment and income. Sometimes further documentation is necessary, so it’s a good idea to have the pay stubs, tax returns and W-2s handy.
If everything checks out, you could have a pre-approval letter in your email within an hour. It is usually valid for 90 days.
When you find a house and it’s time to formally seek a loan, you do not have to use the lender who gave you pre-approval. Your pre-approval letter is “conditional.” It lets sellers know you have the means to buy a house.
Difference Between Pre-Approval and Mortgage Commitment
It’s like the difference between getting engaged and getting married. With pre-approval, you’re saying I want to buy a house. With a mortgage commitment, you’re saying I’m buying the house.
In the pre-approval process, the lender verifies basic criteria like your credit score, employment records and debts. If everything is in order, they confirm that you are worthy of borrowing a certain amount of money. But neither party is obligated to actually walk the down aisle and go through with the loan.
A mortgage commitment takes things a few steps further. An underwriter reviews all of the borrower’s documentation (pay stubs, tax returns, IRAs, etc.). Then they specify the amount of money to be loaned, the interest rate the borrower qualifies for, the type of loan (30-year fixed, etc) and how long the commitment letter is good for.
It means your mortgage has been approved, not just pre-approved. And like a marriage, hopefully everyone will live happily ever after.
Can I Get a Pre-Approval with Bad Credit?
Yes, you can get pre-approved for a mortgage with bad credit.
It’s just not easy.
Lenders look at the whole picture, not just the credit report. Having a lot of money in reserve, a good income, a steady job and small amount of debt can overcome the bad FICO report you got for doing the opposite of all those things.
The hitch is you’ll still have to pay a higher interest rate and make a larger down payment, but at least you’ll qualify for a mortgage.
Many lenders rule out applicants with credit scores lower than 640. But a 2017 study by the technology company Ellie Mae found that 5% of all Federal Housing Administration-insured loans that closed in December of 2016 had FICO scores below 600.
Additionally, 3.4% had FICO scores between 550 and 599, while 1.5% had scores between 500 and 549. So don’t think a bad credit history means there’s mortgage in your future.
What to Do If Rejected for Pre-Approval
The first thing you should not do is take it personally since you are not alone. A 2016 Federal Reserve study found that one out of every eight applicants for a mortgage got turned down in 2015, the most recent year with available statistics.
The first thing you should do is ask for an explanation. You might find the lender made a calculating mistake or got some bad info. If there were no mistakes, ask for a second opinion from someone else in the company. Be prepared to explain the blemish that triggered the rejection.
Perhaps it was a one-time event like a medical emergency, natural disaster or death in the family. If so, have proof to back up your story. You can also try other lending institutions.
If that doesn’t work, accept the problem isn’t the lenders. The problem is you. The good news is you can do something about that.
Increase your income and cut expenses. Nobody’s saying that will be easy, but millions of people figured it out well enough to eventually buy a house.
Repairing your credit is vital, and a lot of people have gotten help through debt-management programs. A nonprofit credit counseling company works with lenders to reduce interest rates on your monthly bills. The credit counseling company consolidates the bills into one payment, which is lower than total you were previously shelling out for all those different bills.
A counselor comes up with a long-term strategy to get you out of debt and keep you there. Your road to recovery isn’t a short one. The process usually takes 3-5 years.
Then the next time you find that ideal house, not only will you know what mortgage pre-approval is, you’ll have the ability to make your dream come true.
Consider Taking a Homebuyer Education Course
You should consider taking a homebuyer education course, especially if you are a first-time homebuyer. Homebuyer education courses help you determine how much you can afford to pay on a monthly basis and identify a purchase price that is affordable for you. Don’t assume that the total a bank pre-approves you for is not the same as what you can personally afford to pay.