While shopping for a home may be pleasant, serious buyers need to start the process in a lender's office, not an open house – and by obtaining a mortgage pre-approval. This process, basically an evaluation that determines whether the borrower qualifies for a loan, is important for several reasons.
First and foremost, in today's real estate market, most sellers expect buyers have one, and may only negotiate with people who have proof that they can obtain financing. Second, would-be homeowners learn the maximum amount they can borrow. They can also have an opportunity to discuss financing options and budgeting with the lender. Finally, if there is any problem with their credit, they'll get a heads-up about it.
Pre-qualification Vs. Pre-approval
Although they sound alike, being pre-qualified for a loan is not the same thing as being pre-approved.
Pre-qualification is the initial step in the mortgage process, and it's generally fairly simple. To pre-qualify for a mortgage, you meet with a lender (though the procedure can also be done over the phone or on the internet), and provide information about your assets, income, and liabilities. Based on that information, the lender will estimate roughly how much money you can borrow. The entire process is informal. It can be useful as an estimate of how much you can afford to spend on a residence, but because it's a quick procedure – and based only on the information you provide to the lender – your pre-qualified amount is not a sure thing; it's just the amount for which you might expect to be approved. For this reason, being a pre-qualified buyer doesn't carry the same weight as being a pre-approved buyer who has been more thoroughly investigated.
With pre-approval, the lender checks your credit and verifies your financial and employment information and documentation; this not only confirms your ability to qualify for a mortgage but approves a specific loan amount (usually for a particular period, such as 90 days).
How to Get Pre-Approved
As you might suspect, the pre-approval process is more formal and involved. You'll complete an official mortgage application (and usually pay an application fee), then supply the lender with the necessary documents to perform an extensive check on your financial background and current credit rating. (Typically at this stage, you will not have found a house yet, so any reference to "property" on the application will be left blank). From this data, the lender can tell you the specific mortgage amount for which you are approved. You'll also have a better idea of the interest rate you will be charged on the loan and, in some cases, you might be able to lock in a specific rate.
"No verification" or "no documentation" loans are a thing of the past. The document requirements for mortgage pre-approval vary by lender and your individual circumstances, but typically, you'll need to provide paperwork which shows your income, your assets and any regular commitments against your income.
1. Proof of Income
These documents will include, but may not be limited to:
- Thirty days of pay stubs that show income as well as year-to-date income
- Two years of federal tax returns
- Sixty days or a quarterly statement of all asset accounts including your checking, savings, and any investment accounts
- Two years of W-2 statements
Borrowers also need to be prepared with proof of any additional income such as alimony or bonuses.
You will need to present bank statements and investment account statements to prove that you have funds for the down payment and closing costs on the residence, as well as cash reserves. If you receive money from a friend or relative to assist with the down payment, you will need gift letters which certify that these are not loans and have no required or obligatory repayment. These letters will often need to be notarized.
"It's important to have a paper trail of where your down payment and closing cost funds are coming from," says Aiman Abozeid, branch manager for Inlanta Mortgage in Madison, Wisconsin. "You can't use any undocumented 'mattress money' for your down payment or money you've deposited from a credit card withdrawal or gambling winnings. If you have any odd deposits, you'll need to document them with deposit slips and an explanation to make sure they aren't unauthorized gifts."
For example, if you are getting married and are relying on the cash wedding presents you will receive for a down payment, lenders want that money deposited into your bank account as soon as possible and may even want to see a copy of your wedding invitation to ensure that the date of the deposit aligns with the date of the nuptials.
Simply put, any sudden change in your finances – for better or worse, but especially better – will need to be explained, and if you cannot document it, it likely won't be counted.
Most lenders today reserve the lowest interest rates for customers with a credit score of 740 or above. Below that, borrowers may have to pay a little more in interest or pay additional discount points to lower the rate. Most lenders require a credit score of 620 or above in order to approve an FHA loan, especially to qualify for a 3.5% down payment; borrowers with a credit score below 580 are required to make a larger down payment of 10% Lenders will often work with borrowers with a low or moderately low credit score and suggest ways they can improve. (For more, see Can You Hit A Perfect Credit Score?)
4. Employment Verification
Your lender will want to see your pay stubs and will likely call your employer to verify that you are still employed and to check on your salary. If you have recently changed jobs, a lender may want to contact your previous employer. Lenders today want to make sure they are loaning only to borrowers with a stable work history. Self-employed borrowers will need to provide significant additional paperwork concerning their business and income.
5. Other Documentation
Your lender will need to copy your driver's license or state ID card and will need your Social Security number and your signature allowing the lender to pull a credit report. Be prepared at the pre-approval session and later to provide (as quickly as possible) any additional paperwork requested by the lender. The more cooperative you are, the smoother the mortgage process will be.
"If you have any unusual income or circumstances, you'll need to provide other documents," says Peter Boyle, a senior loan originator at Summit Mortgage Corporation in Plymouth, Minnesota. "For instance, if you're divorced, I need to see a decree. If you filed bankruptcy, I need a full copy of the discharge documents. If you have rental income, I need a copy of the lease."
Typically, the pre-approval process takes two to four weeks. Some lenders are beginning to experiment with online applications (see Get Approved for a Mortgage in an Hour), which can be much faster.
With pre-approval, you will receive a conditional commitment in writing for an exact loan amount (and often an interest rate as well), allowing you to look for a home at or below that price level. Getting pre-approved for a mortgage also enables you to move quickly when you want to make an offer: It won't be contingent on obtaining financing, which can save you valuable time.
Once you have found the right house for you, you'll fill in the appropriate details, and your pre-approval will become a complete application. Final loan approval occurs when you have an appraisal done of, and the loan is applied to, a particular property.
If Approval Isn't Forthcoming
If you fail to get pre-approved, all is not lost. Believe it or not, it is possible to ask the lender to send your file to someone else within the company for a second opinion on a rejected loan application. In asking for an exception, you'll need to have a very good reason, and you'll need to write a carefully worded letter defending your case.
If the problem lies in your financial past – and it's a particular incident that's instigating the rejection – you might have a chance if you can state the blemish on your record was a one-time event. This one-time event should have been caused by a catastrophe such as a large and unexpected medical expense, natural disaster, divorce or death in the family. You'll need to be able to back your story up with an otherwise flawless credit history.
If the first lender you approach rejects you, there's no reason not to try out a few other financial institutions. Sometimes one lender will say no while another will say yes. If every lender rejects you for the same reason, though, you'll know that it's not the lender that's the problem, it's your financial situation. Your only choice at this point is to fix the problem.
By the way, you can shop around for a mortgage, and it will not hurt your credit, according to the Consumer Financial Protection Bureau, a government agency. Within a 45-day window, multiple credit checks from mortgage lenders are recorded on your credit report as a single inquiry. This is because other creditors realize that you are only going to buy one home. You can shop around and get multiple pre-approvals, and the impact on your credit is the same no matter how many lenders you consult, as long as the last credit check is within 45 days of the first credit check.