Once you have established a realistic monthly budget for home ownership and know how much you can comfortably afford to spend per month, and also how much you can afford for a down payment, the next step is getting pre-approved with a knowledgeable mortgage lender who will take time to counsel you and thoroughly answer any questions you have about the mortgage process. (It’s also a good idea to consult with a Realtor® around the same time you get pre-approved regardless of whether you’re a renter or current homeowner planning to sell your home and purchase a new one, but we’ll discuss this step in the next section).
Often times, buyers will try to start searching for a home prior to getting pre-approved, even going as far as trying to find a home before they ever speak with a lender. This can ultimately be a huge mistake, and is often the result of fear instilled from myths they’ve heard from friends and family that mean well, but are misinformed about how the mortgage and home buying process really works. (Please read my article about Myths of Mortgage Pre-Approval if you are apprehensive about getting pre-approved.)
Also, most home sellers will require a pre-approval letter before they will consider a buyer’s written offer to purchase. Sellers want to know the buyer has the ability to obtain financing before they will normally commit to taking the home off the market and waiting for the transaction to close.
Pre-approval is understandably one of the steps most buyers dread the most, especially first-time homebuyers that have never experienced the process before. However, pre-approval is a very easy process and can usually be done in just a few minutes online or over the telephone.
Although some companies have an online pre-approval and/or application process, I strongly recommend working with a company that will also take the time to consult with you in person or at least over the phone. Every buyer should have an ample opportunity to consult with a loan officer and ask as many questions as they need in order to feel confident they are making a good decision to purchase a home.
WHAT IS MORTGAGE PRE-APPROVAL?
Pre-approval is a tentative, non-binding commitment from a lender for mortgage funding up to a maximum loan amount. It essentially means that the loan officer has viewed the buyer’s credit report and income/employment information and has made a preliminary determination that the buyer should receive full loan approval up to a maximum sales price / loan amount that is included in the pre-approval letter. In some cases, the lender will run the scenario, along with the buyer’s credit and income information, through a software program known as automated underwriting, which will issue a preliminary loan commitment. From that point forward, it’s just a matter of verifying all of the information the buyer has submitted (employment, income, assets, etc.)
Pre-approvals are typically valid for 30-90 days. After that, the lender will usually be required to pull an updated credit report just to make sure no new derogatory information has been reported, especially since some estimates show that up to 80% of credit reports contain errors. Also, let the loan officer know if anything has changed with your employment, income or assets after the initial pre-approval consultation. The loan officer will typically provide a pre-approval letter to the buyer (and their Realtor® if they’ve already chosen a Realtor® to work with) that will be submitted along with a written offer to purchase you find a home that you want to try and purchase.
During the pre-approval process, a lender will typically ask some specific questions about your income, employment, credit history and assets (i.e., money in the bank and money you are comfortable using for down payment) as well as your living history for the last two years. But it’s important to be prepared with your own questions when speaking with a lender. Here are some important questions to ask and an explanation of why these questions are important:
QUESTIONS TO ASK A LENDER DURING PRE-APPROVAL:
· What’s my estimated monthly payment, INCLUDING TAXES AND INSURANCE, at a sales price of X? If you took the time to budget, you should know the maximum monthly payment you’re comfortable paying. Make sure you let the loan officer know you do not want to exceed this amount even if you can qualify for a higher sales price.
· What’s the maximum loan amount that I can qualify for? It’s always a good idea to know the maximum amount you can qualify for even if you aren’t going to purchase a home that expensive.
· I have budgeted $X for down payment. How much, if anything, will the seller need to pay towards my closing costs in order for me to come to closing with $X or less? The amount required for down payment is in addition to closing costs and prepaid items that will also be required by the lender. Most loans allow the seller to contribute money towards your closing costs and prepaids, but we have to ask the seller a specific amount to pay when the contract is submitted.
· How long will your underwriting process take to complete? The Texas Real Estate Contract requires that the buyer(s) and seller(s) agree to close on or before a certain date that’s agreed to in writing before the contract is executed. In many cases, buyers will select a lender based solely on price and rate without taking into consideration whether the lender is actually capable of closing the loan on time. In cases when the lender is unable to complete the closing by the date specified in the contract, buyers must either obtain a contract extension from the seller or potentially run the risk of losing their earnest money, along with all the other upfront fees that have been spent, and have to start over from square one and find a new house. Unfortunately this happens all too often, usually because buyers do not know to ask these questions upfront. It’s not uncommon, especially in busy markets, for lenders to take several weeks to issue loan approvals.
· What are the requirements to lock in an interest rate? Every lender has their own policies for locking interest rates. “Locking” essentially means guaranteeing the rate for a specific length of time, such as 15, 30, 45 or 60 days. Some lenders may lock as long as 90 days or even longer, but the rate is typically higher for a longer lock term. Also, ask about their re-lock policy and fees. Re-locking happens when the original lock term expires (sometimes this can happen as a result of the lender getting backed up and not being able to close on time) and the rate must be re-locked through the new closing date.
ITEMS NEEDED FOR PRE-APPROVAL
Ideally, you should have these items handy for pre-approval:
· Copy of current driver’s license for all applicants.
· Copy of social security card for all applicants.
· W-2 forms and all pages of tax returns for the previous two years.
· Pay stubs for the last 30 days.
· All pages of bank and financial statements for the last two months or most recent quarterly statement for investment accounts that only provide statements once per quarter.
The loan officer will typically ask you to either fax/email copies of these items or bring them in person once you make a full loan application. Make sure you save any new documents that you receive in the meantime (updated bank statements, pay stubs, etc.).
WHAT TO KNOW ABOUT MORTGAGE PRE-APPROVAL
It’s important to understand that pre-approval is NOT a GUARANTEE of loan approval. Full loan approval isn’t possible until a property is selected and the lender’s underwriter reviews all required documentation on the borrower(s) and the property that is ultimately chosen. However, as long as the loan officer does a thorough job of pre-approval upfront, there should be no reason that you will not be approved for the loan as long as FOUR things occur:
· Your financial situation (income, credit, employment status or amount of cash) does not change for the worse. For example, if you lose your job, receive a pay cut or have late payments on an account that’s reported to the credit bureaus AFTER the loan officer initially checks your credit at the time of pre-approval, this may jeopardize your loan approval. ALWAYS be UPFRONT and HONEST with your loan officer because there’s often a way to solve a problem if they know a potential problem exists prior to closing. Lenders will typically conduct a verbal verification of employment on the day of closing, so if you change jobs, let the lender know as soon as possible. Changing jobs doesn’t necessarily mean you won’t be approved for a loan; the lender may just require new pay stubs and verification of employment at your new job.
· The property you ultimately select meets the lender’s minimum property standards and must also appraise for at least as much as the contract sales price. In cases where the property does not appraise for at least the sales price, the One To Four Family Residential Contract gives the buyer the option of going back to the seller and asking them to lower the sales price to the amount of the appraisal. If the seller does not agree, the contract allows the buyer to terminate the contract and receive their earnest money back (See Section 4 (1)(A) of the Texas One to Four Family Residential Contract). In some cases, the seller may not agree to lower the price but the buyer may want the house so bad that they agree to pay the difference between the contract price and the appraisal price (which is normally required by the lender if the lower appraisal amount results in the the maximum loan-to-value ratio being exceeded). In cases where the property does not meet the lender’s minimum standards, the buyer and seller must negotiate how these issues will be resolved. Lenders typically will not allow a property to close that is in need of severe repairs, such as foundation or roof, until those repairs are completed. In some cases, the repairs may be escrowed at closing.
· The lender receives a satisfactory commitment for title insurance, a survey, homeowner’s insurance coverage binder, tax certification, and, in some cases, a satisfactory termite inspection. Once you have a property under contract, the lender requests a commitment to issue title insurance from the title company. This will ensure that you’ll have clear title to the property and that no outstanding liens exist which may cloud title. The title company will also obtain a tax certificate from the county taxing authority to make sure all property taxes have been paid current. You will need to shop some insurance companies to find satisfactory homeowner’s insurance coverage and supply the lender with a binder of coverage. Lenders typically have minimum requirements on the amount and type of coverage, as well as the minimum deductibles. And lastly, although most lenders do not require a copy of the home inspection, many do require a copy of a termite inspection (especially in Texas where termites are common) to make sure there is no active infestation of termites. In cases where termites are found, the buyer and seller will negotiate how to treat the termites, a pest crew will then apply treatment, and the lender is given a copy of the paperwork showing the problem has been resolved.
· The lender receives any other required loan conditions. Typically a lender is going to require some standard items for all loan applicants. As time goes on, the lender may require updated documentation, such as newer pay stubs, bank statements, etc. They may also require proof of liquidation of funds. For example, if you are taking money out of a 401K or receiving a gift for down payment, the lender will require a paper trail showing that money leaving one account and going into another. Also, because of rampant loan fraud in the industry, lenders also typically require the IRS to verify the tax returns you supplied at loan application match the ones on file with the IRS. They do this by sending IRS Form 4506 to the IRS and verifying the transcripts they have on file. So if you haven’t filed your tax returns on time, let your lender know. Sometimes you may be able to file them at an IRS office and have a clerk stamp them as received in order to satisfy this condition.
HOW DOES A LENDER / LOAN OFFICER DETERMINE HOW MUCH I CAN QUALIFY TO PURCHASE?
Each type of government-insured loan, such as FHA, VA and Conventional loans purchased by Fannie Mae and Freddie Mac, have their own specific guidelines for:
- Minimum credit score
- Minimum credit requirements for the last 12-24 months on accounts (e.g., late payments, charge-offs, collections, etc.)
- Minimum time since bankruptcy discharge.
- Minimum time since previous foreclosure or short sale.
- Maximum housing and debt-to-income ratio
- Maximum loan amount
- Minimum down payment required
- Cash reserves required
- Minimum requirements for employment. Most want to see that self-employed buyers have been in business for at least two years. Buyers employed with a company that graduated from college may not be subject to the two year rule if they work in a field related to their degree.
- Specific requirements for different property types, such as condominiums, investment properties and other types of homes that may be at higher risk of default.
In addition to the guidelines for loan types, banks may have their own specific guidelines, called overlay guidelines, that may impose additional qualifications over and above the minimum standards required by FHA, VA or Fannie Mae/Freddie Mac.
A common practice is to run the buyer’s information through a system called “Automated Underwriting”. Fannie Mae, Freddie Mac, FHA and VA all have automated underwriting systems that are essentially computer algorithms that determine how much a buyer can purchase based on the factors listed above. It’s always good for a loan officer to run a buyer’s profile through automated underwriting at the time of pre-approval if possible to minimize the chances of having problems with the underwriting process in the middle of the transaction.
In conclusion, pre-approval should always take place before you really start seriously house-hunting. The process is quick, easy, and is a vital step in ensuring you will make an informed decision when buying a home.