Anyone buying a home who is not in a position to pay cash will probably need to take out a home mortgage. Getting pre-approved for a mortgage can simplify the process when real estate agents approach sellers with offers to purchase. In situations where sellers receive multiple offers from real estate agents, a pre-approval can make an offer more competitive.
Before starting the house-hunting process, buyers should familiarize themselves with the pre-approval process so they know what to expect.
Pre-approval for a mortgage means that a lender has investigated relevant aspects of the buyer’s financial situation. It allows the home buyer to demonstrate to sellers that they can obtain funds to buy the house if the seller accepts their offer.
Pre-approval is different from pre-qualifying for a mortgage. Pre-approval is a more stringent process that involves the lender verifying details from personal finances instead of trusting the information that the buyer supplied.
Pre-qualification is for the buyer’s benefit. It helps the buyer determine a price range and mortgage payment amount. Pre-approval helps the bank and sellers verify that the potential buyer is in a financial position to purchase the property.
Pre-approval does not mean that the lender has approved a loan: Approval won’t happen until a purchase contract is in place.
The first step in the mortgage pre-approval process is submitting the mortgage application. On the application, the applicant will answer questions about their finances.
Identity theft is a pervasive problem in the lending and credit industries today. The lender will need to make sure that someone else is not fraudulently applying for a mortgage in the applicant’s name. Applicants will typically have to provide the following information.
The lender will want reassurance that the home buyer has a steady source of income that will pay off the loan. The precise income requirement may vary, but in general, monthly income should be at least four times the expected mortgage payment. Generally, the lender will want to see W2 forms or other proof of income for mortgage pre-approval.
Homebuyers who are self-employed may have to take additional steps to verify their income. They may have to verify that they have been in business for at least two years. Income from the past two years can be used as a basis for the buyer’s projected income. For example, if a buyer made $56,000 one year and $40,000 the year before, their income would average out to $48,000 a year or $4,000 per month.
The lender will want to see bank statements, account statements for investment accounts, and other documentation for assets.
The buyer’s physical and non-physical assets are relevant to the pre-approval application because the buyer could liquidate them if, for instance, they were laid off or experienced a disruption in income for some other reason.
Cash assets and physical assets (such as a car or boat) are valuable because they can be available quickly. Other assets, such as a retirement plan, might be less valuable to the lender. Buyers should be as complete as possible in disclosing their assets and include stocks, a stake in a business, royalties, or anything else the buyer could use to repay the loan if they run into financial trouble.
The lender will verify that the buyer has a steady source of income. Ideally, this would be a job that the buyer has held for at least two years. If a buyer has changed jobs, the lender will look for evidence of stability. For example, a promotion to a supervisory position might count in the buyer’s favor, while a layoff or switch to a lower-paying job might put the buyer at a disadvantage.
Once the lender has checked the buyer’s credit, it will look at the buyer’s existing debt, such as other mortgages, car loans, student loan debt, and credit card debt. Credit card debt can be a red flag if it indicates that the buyer is spending more than they earn.
The lender calculates the debt-to-income (DTI) ratio, a measure of creditworthiness. According to the credit reporting agency Experian, a DTI under 43% is necessary for a qualified mortgage.
The time it takes to get a pre-approval letter may vary depending on how long it takes the lender to verify the details and reach a decision. It typically takes a few days up to a week.
The mortgage pre-approval letter from the lender will include a statement of the loan amount, interest rate, type of loan (for example, fixed-rate or variable rate), and the expiration date of the letter.
After the buyer has obtained pre-approval, it is in the buyer’s best interest for their finances to be as stable as possible until the mortgage lender approves the loan.
If any of the details in the application change, the lender might no longer be willing to lend on the preapproved terms. For example, a drop in the buyer’s credit score, or a change in interest rates for adjustable-rate mortgages, might mean that the buyer no longer qualifies for the loan at the pre-approved rate.
The lender might still be willing to lend in these circumstances if the buyer pays additional money upfront. This is called “buying points.” Even if the buyer’s finances haven’t changed, the buyer might elect to buy points on the mortgage to reduce the interest rate.
If your financial situation is complicated, or if you are uncertain about the pre-approval process, you don’t have to handle it alone. Cornerstone Capital Financial Services, LLC can help you find financing for your new home. We offer a range of financial products and services. Apply on our website or call us at 201-265-4545 for a consultation today.