There are many steps to becoming a home-owner, one of the first steps is getting a loan pre-approval. It is very helpful for a borrower to demonstrate to the home seller that they are serious and well-positioned to quickly move on a transaction, and loan pre-approval provides that confidence. The CEO of Detroit-based Quicken Loans says that a pre-approval document sends a strong signal about the borrower from the lender.
One quick note, ‘pre-qualification’ is different from pre-approval. Pre-qualification is typically a rudimentary process of simply checking the prospective borrower’s employment and income. Pre-approval is a lengthy endeavor whereby the lender specifies the terms of the loan based on the borrower’s situation and steps to execute the loan. Pre-qualification is the audition while pre-approval is the dress rehearsal. The final loan origination & underwriting is the real show, and the final loan terms could still be somewhat different than the pre-approval figures.
Before you go about getting pre-approval, it can be helpful to improve your credit score. Under the Fair Credit Reporting Act, an individual is entitled to view their credit report once per year from each of the three major credit reporting agencies: Experian, Transunion & Equifax. That means you can actually view your report once every four months. Another tool in your toolbox – many credit card companies offer free credit score access to their customers. Finally, there are free & secure websites for individuals to check out their credit profile and an estimate of their FICO (Fair-Isaac Corporation) score without dinging your credit.
Pre-approval not only helps your potential seller but also streamlines the whole process for you, the prospective buyer. Pre-approval provides you a ballpark of how much house you can afford. A word to the wise (and prudent) though, you do not have to shop for a home with a price tag up to the very top dollar of your pre-approved loan amount. Some experts say you should aim for about 90% of that value to be safe. Still, you want to run your own numbers as the bank may actually approve you for a loan amount that is above what you can afford. Two rules of thumb for your own calculations are keeping your mortgage amount below 28% of your gross monthly income and having your total recurring debt no more than 36% of your income. Also, aim for a down payment of 20% of the house value to avoid paying pesky Private Mortgage Insurance (PMI).
Another benefit of getting a loan amount pre-approved – it lets realtors know that you are a serious buyer (customer). The best realtors may not want to waste their time on those who are not motivated and prepared for the process.
Mortgage pre-approval can only help you as a potential buyer. As always, shop around for the most favorable loan rate and be patient with the process.
Here’s the point:
- Pre-approval is a lengthier process in which a lender provides a document stating how much money they would lend a prospective home-buyer.
- Pre-approval signals to the seller and to a realtor that you, the buyer, are serious about transacting.
- It is often wise not to take out a loan up to the very limit of the pre-approved amount – be sure you are buying only enough house that you can afford.
Action Items:
- Check your credit report & score prior to the process; work on improving your score.
- Use online tools in your research as some parts of the process are now online.
- Talk with us at TFC to discuss your cash flow situation and how owning a home fits within your long-term financial plan.
Photo by Tierra Mallorca on Unsplash