Why a pre-approval should be your first stop in the home-buying process
But if the mortgage process has you all confused, you’ve come to the right place! We’re breaking down the pre-approval process and how it can get you closer to your homeownership dreams.
What’s the difference between pre-approval and pre-qualification?
You may have heard the terms pre-approval and pre-qualification thrown around together when talking about mortgages, but they actually mean pretty different things. Let’s break it down.
Pre-qualification: This is mainly based on a casual conversation about your credit scores, income, monthly payments and what you have available for a downpayment and closing costs. Your lender is basically just utilizing what you've told them, without extra verification, to give you a rough estimate of what you can afford (but this isn’t really an exact measurement).
Pre-approval: This involves verifying and taking a deeper dive into all of the information you provided in your loan application (AKA checking your pay stubs, W-2s, bank statements, etc.). Your lender will also pull your credit report from multiple bureaus to see your credit history. This allows your lender to have a much better idea of the budget and loan you can afford.
Why should I get pre-approved for a mortgage?
Let’s talk more about the benefits of getting a pre-approval (in case you aren’t convinced yet).
- House hunt with ease: Getting a pre-approval BEFORE you look for your dream home can actually make the process easier. Plus, a lot of real estate agents require you to get one anyway. But even if they don’t, it helps you avoid accidentally looking at homes you think you can afford, falling in love and then realizing it’s not in your budget.
- Make a stronger offer: When looking at homes in a competitive market or as a first-time home buyer, being pre-approved could give your offer an extra edge over the others. That pre-approval signals to the seller that your offer will likely go through and can be trusted.
- Save time later on: Buyers and sellers can both have reasons to want to get to closing fast. No matter your reasoning, getting pre-approved at the start can save you time later on because you’re getting most of the process done then. This way, if your offer is accepted, you have a lot less to worry about.
What's needed for me to get a mortgage pre-approval?
Like most things in life, getting pre-approved takes a little elbow grease (but don’t worry, it’s not really manual labor). LUCKILY, most of it is done by your lender.
Before a pre-approval is even considered, they'll check several things to get a better picture of your current situation. Financial stability is a big one, but others include*:
- Income amounts for the past few years
- Type of employment and industry
- Current expenses
- Open debt
- Credit history
- Amount of downpayment already saved (or anticipated to have upon closing)
- Assets (property owned, etc.)
- Financial Stability
*This is not an exhaustive list. Please reach out to a loan officer for your specific situation.
How is my loan amount determined?
The amount you qualify for often depends on your lender’s standards and requirements (every lender is a little different). But if they give you a thumbs-up after reviewing the factors above, they'll provide an amount they're willing to let you borrow for your house purchase. (Yay!)
To get a little more specific, lenders typically focus on the following three things to help them determine if you are eligible for pre-approval and, if so, for what amount.
Gross income
To determine what kind of monthly payment you can afford, mortgage lenders will analyze your debts and look at your gross income — not your net take-home pay. Gross income is the sum of all wages, salaries, interest payments and other earnings — before taxes.
Why is gross income used instead of net income? Because borrowers are more familiar with how much they make a year than how much they take home every month, especially if they're paid weekly or bi-weekly.
Debt-to-Income (DTI) ratio
Your DTI is your gross income compared to how much debt you have. That formula will help determine a total monthly mortgage payment you feel comfortable with (including principal, interest and taxes). That figure should be no more than 28% of your gross monthly income.
They then take that number and add in all your monthly debts like car loan payments, monthly credit card minimums and student loan bills. This new figure should be no more than 36% of your gross monthly income.
Having a high DTI can signal that your debts may impact your ability to make your monthly mortgage payments, which can interfere with getting the loan or lower the amount you can borrow.
Credit score
Once gross income and DTI are figured out, lenders will look at your credit score. Even if you have a high DTI, don’t lose hope yet! A favorable credit score may increase your chances of getting pre-approved for a loan because it shows you can handle a higher amount of debt.
Remember, every loan and lender has different credit score benchmarks, so if you don't meet the requirements for one type of mortgage, you might meet those of another!
Can I lower my monthly mortgage payments?
Once you're pre-approved for a loan, you'll have a good idea of how much you can pay every month. But what you may not know is that you can actively influence that outcome.
Here are four ways you might be able to lower your monthly mortgage payment*.
*Total finance charges may be higher over the life of the loan.
Improve your credit score
With a higher credit score, you increase your chances of being offered a lower interest rate — hence lower payments.
To improve your credit score, follow these tips:
- Do your best to pay every bill you get on time
- Pay off your debt
- Make payments more than the bare minimum
- Keep balances low on your credit card accounts
Lastly, remember closing unused accounts can negatively impact your credit score, so don't do it until you've closed on your new house.
S-t-r-e-t-c-h the mortgage term
A mortgage term is the time you have to fully repay the loan. For most mortgages, terms are either 15, 20 or 30 years, and if your payments are extended over a longer time, they'll end up being lower. Extending the loan may increase how much interest you end up paying over the long haul, BUT it can reduce your DTI and help you get the loan approved in the first place.
Save up more for your down payment
Down payments of 20% of the purchase price used to be commonplace, but these days, some loans programs are available to borrowers putting only 5%, and sometimes 0% for qualified borrowers!
If you really want to lower your monthly mortgage payment, you may want to put down more cash than you originally planned to. The higher your down payment, the lower your monthly payment will be.
Say goodbye to PMI
When house prices were lower, it used to be the norm for first-time homebuyers to try and save for a 20% down payment. With people putting up less than that, lenders are taking a bigger risk that a borrower may default. So they take out private mortgage insurance, or PMI, to guard against that.
Unfortunately, they don't pay for the insurance; you do — it's added to your monthly mortgage payment. But by putting 20% down — or by eventually getting to 20% equity through multiple monthly payments, you can get rid of PMI altogether, which will lower your monthly home loan payment.
Pre-approval vs. final loan approval
But what about the difference between pre-approval and final loan approval??
Although getting a pre-approval gets you a lot closer to homeownership than pre-qualification does, you’re still not quite there yet. Your final loan approval is the last stop, which can involve:
- Providing a purchase contract with details on the home you want to buy
- Having a home inspection to make sure it’s in tip-top shape
- Having a home appraisal, hired by your lender to double-check the home’s value
- Having your lender order a title report checking for any liens or issues with previous owners
- Getting your loan application checked thoroughly for accuracy
If all of these steps are completed, then you’re likely clear for closing!
So what are you waiting for?
Getting pre-approved well BEFORE you even shop for a home will help eliminate a lot of the stress associated with the mortgage loan process. If you're a prospective homebuyer with questions about home financing, please reach out to a loan officer near you to get started.
