What you need to know about the pre-approval process.
I speak to hundreds of buyers every year, new home buyers sometimes believe they are are too early in the process to obtain a pre-approval. Let me be clear here, it’s never too early. A pre-approval letter lasts for a while and you, as a buyer, need this (not to be confused with a pre-qualification letter, which means nothing) to know exactly what you can afford to buy. The Realtor© representing you, will need this to search for listings in your budget. Last but not least, this pre-approval is submitted with your offer to purchase to sellers to know that you can obtain a mortgage to purchase their home.
What is a pre-approval?
Pre-approval means a conversation with a lender who will make a call on whether you’re eligible to qualify for a home loan and how much you can qualify for. They come to these conclusions based on proof of finances provided by the potential buyer as well as a few other things, employment history etc.
Why Do I Need to Get Pre-Approved?
When I first sit down with my buyers to assess their needs, they sometimes attempt to give me their credit score and see if I can figure out whether they can get a mortgage. I do not sell mortgages, I only sell real estate. I carefully explain that the lenders they should be working with, are ones that have a myriad of products that can help them obtain the specific home you’re looking for. For example, portfolio loans; many major banks will not take on giving a mortgage to a condo building who’s owner to renter ratio is askew or have trying finances. Also many condo buildings will not accept FHA loans. Talk to a lender who can help you with these issues. Bottom line, real estate is the best investment in your life by creating equity. Equity creates wealth.
Often people don’t realize how much money they’ll actually need to put down and how that relates to how much house they want to buy. Different down payments affect your monthly payments, mortgage insurance, etc.
By working with a lender, you can run different scenarios to help you determine the best strategy when deciding critical factors like house cost and size. For example, you may think you’ll save money by buying a smaller condo. But after factoring in monthly homeowner association assessments (monthly dues you pay to the condo association), you might find that a single-family home is actually more affordable.
When it comes to loans, a common mistake that people make is assuming that a loan product their friend used will work the same for them. Although there’s a possibility it could work for you, it’s not a safe assumption to make. No two loans are alike just as no two people’s finances and life circumstances are exactly the same. Another common mistake is to use automated or online banks, that may end up costing you in the long run, due to varying rates and difficulties in certain markets those companies may not be familiar with. Ask your loan officer for their experience in the market in which you are looking to buy.
It’s important to note that loan products have different costs, such as varying lender origination fees. You can work with a loan officer to help learn the cost of a loan, how the loan process works, and which products will work for you. While your costs might not be exact at this stage, you can get a good idea of what to expect.
Gaining this awareness and comfort of shopping for a house that you know you can afford and make payments on, is perhaps one of the biggest reasons to get pre-approved.
Being pre-approved shows buyers that you are serious and prepared to make an offer. In some competitive markets, people won’t even consider an offer unless a pre-approval letter comes along with it. Most recently, I’ve started to see buyers send me mortgage commitment letters to get the leg up against other offers. Some markets are still exceptionally competitive, like Bayonne, Jersey City and the surrounding Hudson & Bergen County areas. As your lender and Realtor© about how to help you win a bid, in a multiple bid scenario. Your lender and Realtor© should be working together to get you to your goal of moving into your dream home.
Is it a Tough Process?
Getting pre-approved is a pretty simple process. You need to know your financial situation — how much money you consistently make, your assets, how much debt you have, and the sources of those debts — and articulate it clearly to your lender. Articulate is the key word here. Although many people wish buying a home was completely automated, from the inception, you will need to be active in speaking with a lender, a Realtor©, an attorney, home inspectors etc etc. Your Realtor© and attorney will be doing most of this but you are as equally involved in the process as the rest of your team.
What Will My Lender Need to Check During Pre-Approval?
Your credit score. Yes, your lender will then have to pull your credit. Don’t worry, pulling your score once shouldn’t affect your score and pre-approval last for 3-6months, which keeps you on a timeline.
- W2s or 1099s
- Pay stubs
- Tax returns
- Bank statements
- Account statements
- Your list of monthly expenses
Gathering all these documents can feel like busy work and is typically the hardest part for you.
If you want to have an idea of whether you’ll get pre-approved before choosing a lender, a good first step is finding out your debt-to-income ratio, or DTI. Your DTI ratio helps a lender understand how much of your monthly income goes to paying debt and what you have left after those debts are paid. You can calculate the ratio by dividing monthly debt payments by gross monthly income.
The lower your debt-to-income ratio is, the better. A lower DTI will make you seem less risky to lenders.
Although each loan product is different, most lenders would prefer your debt-to-income ratio to be at 36% or lower.
Our friends at House Logic made a simple worksheet to help you easily deduce your own debt-to-income ratio. You can download and print yours here.
What Comes After Pre-Approval?
If you can’t get pre-approved, it can be a sign that you aren’t ready to buy a house yet. In that case, work with your lender to identify what you need to change or improve before trying again. If you are pre-approved, then comes the fun part!
Basically, with your pre-approval letter you are ready to go out and confidently look for homes with the help of your Realtor©. When you make an offer that’s accepted, you’ll officially apply for a loan, and the lenders will go over all your documents again.
Note that you have the option to choose a lender thta didn’t grant your original pre-approval.
In fact, once an offer is accepted, it’s a good idea to get a loan estimate from two to three different lenders and compare them to see which terms are the best fit for you. Things to consider are loan fees, interest rate, and annual percentage rate.
By the way, APR (annual percentage rate) is a good measure of your loan costs because it’s broader picture of your costs than the interest rate. It takes into account points and mortgage fees among other things. So it’ll be higher than the interest rate.
The lender will let you know how long you have to decide on a mortgage before your loan offer expires. Once you decide on a lender, it’s time to go buy your dream house!
Remember: Don’t be overwhelmed! One of the many reasons to choose a professional loan officer and a good Realtor© is that they can help explain these processes and walk you through the difficult steps. That being said, I hope this article helped you to understand the basics about the pre-approval process.
My team and I are here to help with all of it!