You've probably heard of the “pre-approval process,” but many people don't know or fully understand what it actually means. I’m excited to chat with you guys about this process and answer some frequently asked questions!
What is Pre-Approval?
Pre-approval means a lender basically makes a call on whether you’re eligible to qualify for a home loan and how much you can qualify for. They come to these conclusions based on proof of finances provided by the potential buyer.
Why Do I Need to Get Pre-Approved?
There are many reasons why pre-approval is not only necessary but also beneficial for you! Often people don't realize how much money they’ll actually need to put down and how that relates to how much house they want to buy. Different down payments affect your monthly payments, mortgage insurance, etc.
By working with a lender, you can run different scenarios to help you determine the best strategy when deciding critical factors like house cost and size. For example, you may think you’ll save money by buying a smaller condo. But after factoring in monthly homeowner association assessments (monthly dues you pay to the condo association), you might find that a single-family home is actually more affordable.
When it comes to loans, a common mistake that people make is assuming that a loan product their friend used will work the same for them. Although there’s a possibility it could work for you, it’s not a safe assumption to make. No two loans are alike just as no two people’s finances and life circumstances are exactly the same.
It’s important to note that loan products have different costs, such as varying lender origination fees. You can work with a loan officer to help learn the cost of a loan, how the loan process works, and which products will work for you. While your costs might not be exact at this stage, you can get a good idea of what to expect.
Gaining this awareness and comfort of shopping for a house that you know you can afford and make payments on, is perhaps one of the biggest reasons to get pre-approved.
Being pre-approved shows buyers that you are serious and prepared to make an offer. In some competitive markets, people won't even consider an offer unless a pre-approval letter comes along with it.
Related: How to Choose a Mortgage Lender
Is It Hard to Get Pre-Approved?
Getting pre-approved is a pretty simple process. You need to know your financial situation — how much money you consistently make, your assets, how much debt you have, and the sources of those debts — and articulate it clearly to your lender.
What Will My Lender Need to Check During Pre-Approval?
- Your credit score. Yes, your lender will then have to pull your credit. Don’t worry, pulling your score once shouldn’t affect your score.
- W2s or 1099s
- Pay stubs
- Tax returns
- Bank statements
- Account statements
- Your list of monthly expenses
Gathering all these documents can feel like busy work and is typically the hardest part for you.
If you want to have an idea of whether you’ll get pre-approved before choosing a lender, a good first step is finding out your debt-to-income ratio, or DTI. Your DTI ratio helps a lender understand how much of your monthly income goes to paying debt and what you have left after those debts are paid. You can calculate the ratio by dividing monthly debt payments by gross monthly income.
The lower your debt-to-income ratio is, the better. A lower DTI will make you seem less risky to lenders.
Although each loan product is different, most lenders would prefer your debt-to-income ratio to be at 36% or lower.
I made a simple worksheet to help you easily deduce your own debt-to-income ratio. You can download and print yours here.
What Comes After Pre-Approval?
If you can’t get pre-approved, it can be a sign that you aren't ready to buy a house yet. In that case, work with your lender to identify what you need to change or improve before trying again.
If you are pre-approved, then comes the fun part!
Basically, with your pre-approval letter you are ready to go out and confidently look for homes with the help of your real estate agent. When you make an offer that’s accepted, you’ll officially apply for a loan, and the lenders will go over all your documents again.
Note that you have the option to choose a lender thta didn’t grant your original pre-approval.
In fact, once an offer is accepted, it’s a good idea to get a loan estimate from two to three different lenders and compare them to see which terms are the best fit for you. Things to consider are loan fees, interest rate, and annual percentage rate.
By the way, APR (annual percentage rate) is a good measure of your loan costs because it’s broader picture of your costs than the interest rate. It takes into account points and mortgage fees among other things. So it’ll be higher than the interest rate.
The lender will let you know how long you have to decide on a mortgage before your loan offer expires. Once you decide on a lender, it’s time to go buy your dream house!
Remember: Don't be overwhelmed! One of the many reasons to choose a professional loan officer and a good real estate agent is that they can help explain these processes and walk you through the difficult steps. That being said, I hope this article helped you to understand the basics about the pre-approval process.
Good luck, friends!
Related: How to Get Home Financing