Ready to hit the housing market? Just a few short years ago, it was so easy: if you wanted a mortgage to purchase a new home, a bevy of lenders scrambled for your business. No down payment? Shaky credit history? No problem!
Then the sub-prime mortgage market tanked, taking the broader mortgage industry down with it, and things changed in a hurry. Now getting pre-approved for a mortgage on the home of your dreams requires some preparation on your part.
Take these steps first:
- Contact mortgage lenders to ask about the mortgage pre-approval process. Most lenders require you to fill out a mortgage application to learn more about your financial stability and employment.
- Start organizing: Lenders will need to verify a wide variety of financial information, such as income, savings, debt and your employment history to determine if you qualify for pre-approval. You’ll need to provide copies of tax returns for the past two years, W-2 forms for the past two years, bank statements for the past six months and other financial documents requested by lenders.
- Get your financial house in order: Work on reducing credit card debt, car loans and student loan debt before applying for pre-approval for a mortgage.
- Increase your savings if you can: The majority of lenders require a down payment of at least 3.5 percent for FHA loans and 5 percent to 20 percent for other types of loans.
- Stay put in your job: Maintaining a solid employment history is critical. Apply for mortgage pre-approval after working for the same employer for at least six months.
- Work on increasing your credit score: Avoid taking out new loans for cars and other high-ticket items. For mortgage pre-approval, you should have a credit score of at least 650. Those with credit scores of 750 or higher qualify for the best interest rates.
The mortgage process can be broken down into three parts: pre-qualification, pre-approval and final approval.
Pre-Qualification
In pre-qualification, a mortgage lender takes a cursory review of your financial situation to provide a ballpark figure on how much they might be willing to lend you. Pre-approval is a more in-depth review process, in which a lender will request a variety of financial documents to review your credit score and other factors relating to your financial history. Based on this review process, the lender will tell you how much they are willing to lend you. It's not a commitment by the lender, but it does give you a good idea of where you stand. Then, after you make an offer to buy a house, you will go back to your lender for the final approval. They will review the purchase agreement and then send a professional appraiser to determine the value of the house. If everything checks out, you will be approved for the loan.
It’s best to start the mortgage process with pre-approval well before bidding on a home, as your financial house needs to be in order to qualify for the best rates and to determine how much you can afford. Pre-approval for a mortgage helps you identify any problems you have in terms of mortgage approval.
Pre-approvals are important because they allow you to shop with confidence, knowing that your financing is in place so that when you find the house for you, you won’t face a mad rush to obtain a mortgage.
Pre-approval means you have met with a loan officer who reviewed your credit files and determined that you can readily qualify for a given loan amount with one or more specific mortgage programs. This is another great benefit of pre-approval, because your lender also will suggest programs that best meet your needs. If you are a first-time buyer, you may qualify for state-backed mortgage programs with little money down and low interest rates. If you are a repeat purchaser with more equity you might want to look closely at a 15-year loan and the lower overall interest costs it represents. Typically, first-time buyers should opt for the traditional 30-year loan with a fixed rate of interest over the life of the loan. The payments will remain the same for the life of the loan, providing you with a clear picture of what you’ll pay monthly.
The lender then provides you with a pre-approval letter showing your borrowing power. While a pre-approval letter is not a final loan commitment, it can be a powerful tool in the home shopping process, demonstrating your financial strength. That is important to owners since they do not want to accept an offer that is likely to fail because financing cannot be obtained. Real estate agents will be more willing to work with you, and sellers will be more inclined to take your offer seriously. You can actually include a copy of your pre-approval letter with your purchase offer. This is a good practice, because it shows the seller you can afford the amount you're offering.
There is no limit on how many pre-approval letters you can obtain from various lenders, but keep in mind that each one carries with it a new credit check, which will show up on future credit reports and lower your credit score.
STEP ONE: Find Your Lender(s)
The Internet is a great starting point for the mortgage process, allowing you to compare a lot of different products and receive offers from a wide variety of lenders. You can enter data on your household finances and generate estimates easily to create budget forecasts, and you can get pre-approved online as well.
On the other hand, the online channel can be awfully impersonal. If you have a complex financial situation – if you’ve recently changed jobs or experienced financial hardships in the past -- then you might have issues you don't even know about that could hold up a loan at the last second.
If you need personal service, find a mortgage broker or loan officer by asking friends and associates, or your realtor, for recommendations. If you have an existing bank relationship that you are happy with, that’s a great place to start.
STEP TWO: Get Your Paperwork In Order
Start pulling together the key financial documents needed for pre-approval before you're ready to go through the pre-approval process. This is especially important if you are seeking online pre-approval, because you’ll have to have scanned in the documents for electronic delivery.
At a minimum you will need to be able to produce these documents to start the pre-approval process:
- At least a full month of paystubs for anyone listed on the application as a source of income
- Two years of W-2s (or two years of tax returns if you're self-employed)
- Bank statements from the last three months
- If you are currently renting, proof of the last 12 months of rent payments
Generally you can expect pre-qualification within 24 hours and a full mortgage commitment in about 10 days. That’s largely a reflection of how prepared you are, though. The quicker you can provide the right documents and answer all the questions that need to be answered, the more streamlined the process becomes.
STEP THREE: Work Out A Budget
This is another good reason for establishing a relationship with a loan officer or mortgage broker, as they can help you build a realistic budget as part of the pre-approval process. It’s important that you look not only at income, but at your expenses, and that you get a good sense of the expenses that come with owning a home. Factoring in the costs of a mortgage means not only considering the loan’s principal, but also interest, taxes and insurance. The mortgage industry calls the total costs of a mortgage the “PITI” – the principal of the mortgage, plus interest, taxes and insurance. Handy online PITI calculators can help you get a clear picture of these costs.
STEP FOUR: Get a Few Quotes…And Start Shopping!
Once you’ve gotten your first pre-approval letter, it’s easy to shop around and get two or three more quotes. There is no need to go through the entire process: instead simply contact other lenders and tell them that you have a pre-approval letter at a certain rate for a certain amount, and ask how other lenders compare. Ask for their rates and closing costs, and see if there is a difference. If a big difference arises among lenders, make sure you have those quotes in writing before you commit to one over the other.
It’s worth remembering that a pre-approval does not mean approval. The only time you can be certain of your mortgage approval is when you formally apply and close the deal by moving from pre-approval to a formally accepted application. It’s also worth keeping in mind that your mortgage pre-approval is based on your financial situation, so any major changes to your bottom line between now and your scheduled closing date could result in being denied for the loan.
This means that it’s important for you to keep your financial situation as stable as possible following pre-approval. Don’t tap into your savings, don’t make a major career move, and don’t do anything that could reduce your assets or increase your debt level. A pre-approval is subject to your continued good credit and usually remains valid for 60 or 90 days, after which you must reapply in order to make sure the loan offer is still good.
