The Pre-Approval Process: Preparation Precedes Success
In today’s market, if you wait until you find the house of your dreams to get approved for a mortgage, a potential buyer who has a pre-approval letter in-hand is likely to snatch it away from you.
If you need other reasons to obtain pre-approval for a home mortgage loan even before you start to look, see our article Pre-Approval for a Home Mortgage Loan: Why It Is Important.
Getting pre-approval doesn’t oblige you to borrow from that lender. When you’re ready to make an offer, you can choose a lender that you know will be by your side to guide you through what could be the most important process of your life—buying a home. But to start the process, you do have to fill out a mortgage application with a lender, provide the documents that verify your information and meet some standard criteria that ensures you will repay your mortgage.
An easy way to get started is to locate all the documents you will need. The following are fairly standard, depending on your circumstances:
- Driver’s license or U.S. passport
- 30 days of pay stubs
- 60 days of bank statements
- Income tax returns
- W-2 tax returns from the previous two years
- Schedule K-1 (Form 1065) for self-employed borrowers
- Asset account statements: retirement savings, stocks, bonds, mutual funds, etc.
- Divorce papers (to use alimony or child support as qualifying income)
- Gift letter: Many types of loans allow borrowers to use a financial gift from a relative toward the down payment. If you do this, you must complete a standard gift letter in which you and the gift donor verify that the gift isn’t a third-party loan with an expectation of repayment. Additionally, both you and the donor will have to provide bank statements to show the transfer of cash funds from one account to another.
Standard Criteria lenders evaluate before they decide to pre-approve you for a mortgage:
- Employment history
- Debt-to-income ratio (DTI)
- Assets and liabilities
- Loan-to-value ratio (LTV)
- Credit history and FICO score
To determine your DTI ratio, lenders add up debts such as auto loans, student loans, charge accounts, and other lines of credit—plus the new mortgage payment—and then divide the sum by your gross monthly income to get a percentage. Depending on the loan type, borrowers should maintain a DTI of 50% or less to qualify for a mortgage. Lenders prefer borrowers with a lower DTI because that indicates there is less risk that you’ll default on your loan.
Your LTV ratio is calculated by dividing the loan amount by the home’s value. A property appraisal determines the property’s value, which might be lower or higher than the seller’s asking price. The higher your down payment, the lower your loan amount. If you put down less than 20% percent, you might be required to pay for private mortgage insurance (PMI). To lower your LTV ratio, you either need to put more money down or buy a less expensive house.
Credit History and FICO Score
Lenders pull your credit reports from the three main reporting bureaus—Equifax, Experian, and Transunion. They look at your payment history, how many and what type of credit lines you have open, and the length of time you’ve had those accounts. They analyze how much of your available credit you actively use. Most lenders require a FICO score of 620 or higher to approve a conventional loan, and some even require that score for a Federal Housing Administration (FHA) loan. The lowest interest rates usually go to customers with a credit score of 760 or higher.
If you have not opened credit cards or any traditional lines of credit—such as a car loan or student loan—you might have trouble getting a mortgage pre-approval letter. You can build your credit by opening a starter credit card with a low credit line limit and paying off your bill each month. It could take up to six months for your payment activity to be reflected in your credit score.
After reviewing your mortgage application, a lender usually gives you one of three decisions: pre-approved, denied outright, or pre-approved with conditions. To meet the conditions, you might need to provide extra documentation or lower your DTI ratio by paying down some credit accounts. If you are denied outright, the lender should explain exactly why and explain how to best overcome the problems.
If you are pre-approved, your lender provides you with a pre-approval letter on official letterhead. This document indicates to sellers that you’re a serious buyer and verifies that you have the financial means to make an offer to purchase their home. Most sellers expect buyers to have a pre-approval letter and will be more willing to negotiate with those who prove that they can obtain financing.
If you are making an offer on a specific home, the pre-approval letter typically includes the purchase price, loan program, interest rate, loan amount, down payment amount, expiration date and the property address. Getting a pre-approval doesn’t guarantee that a lender will approve you for a mortgage, especially if your financial, employment, and/or income status changes during the time between pre-approval and underwriting, or if you fail to disclose relevant information.
A Citywide Loan Officer is ready and willing to guide you through the pre-approval process, making it easy for you to know if you qualify for a loan, or to expedite the purchase process, if you are ready to start seriously looking for that new home of your dreams.