Pre-Approval for a Mortgage

Once you have made the decision to purchase a home and have a general idea of what you can afford, your next step should be to obtain pre-approval for a mortgage.

Before you actually start house hunting, you should consult with different lenders and go through the process of getting approved for a mortgage. You will present the financial information necessary for the lender to ascertain what you can afford (in their opinion) to borrow and pay back.

Doing this before you start house hunting is a good idea because it can save you a lot of time and money. By knowing what price range you can afford, you save yourself application fees for loans, which can get pricey, that don't pan out. In addition, the seller is happy, because they know pre-approved buyers are serious about making a purchase. Finally, you'll have an easier time when you actually put in an application for a mortgage, because you have already run all your numbers through.

Tip It's important to note the difference between pre-qualifying for a mortgage versus being pre-approved for a mortgage. Just because you qualify for a mortgage, does not mean you are approved for that mortgage. Pre-qualifying simply gives you an idea of what mortgage amount lenders will approve for you when you actually apply for your home loan, whereas pre-approval is a more formal process that determines what loan amount you're eligible for and the pre-approval is usually good for a specific number of days, generally 30, 60 or 90 days.

You may be wondering why you need to be pre-approved for a mortgage, when you can use the same formulas the lenders use to figure out your affordable price range on your own. It is true that most lenders look at ratio of income and debt formulas and the size of your down payment to determine how much home you can afford, but other factors do make up a part of their decision on what you can afford. Let's look at some of these other factors:

Net Worth. Your net worth is basically comprised of all your assets less all your liabilities. Lenders need to know what your net worth is before they determine if and what amount they will loan you to purchase a home. You'll need to provide this information to them by creating a net worth statement. (In our discussion of inventorying your assets and liabilities, we have provided a net worth form you can use when applying for a mortgage.)

Employment. Lenders consider your employment, both past and present, to be a major factor in the amount you can borrow. We are not talking about the amount of income here, but things like how long you have held your present position. Is it a temporary position or a permanent one? And is your job in a field suffering from cutbacks? Your past employment history will be a factor as well. Have you jumped around among various employers? Perhaps you have gaps in your work history where you were unemployed. The amount of weight given to each of these employment traits differs depending on the lender.

Credit History. Your credit history is a major factor that lenders consider when deciding whether to loan you money. After all, your pattern of paying your debts is what they're counting on to get their money back. If you're the type that pays for everything in cash or a young married couple out of college who hasn't established any credit history, this could be considered a risk for lenders as well, since your payment patterns are unknowns. Needless to say, even if your income to debt ratio is good, but you have a history of delinquent payments or non-payments, this may lower the amount a lender is willing to loan you. In the alternative, a lender may only agree to lend you money to buy a home if you pay a higher interest rate or put up a down payment of more than 20 percent to offset their risk.

Tip Before you begin the pre-approval process, you should get a copy of your latest credit report and check it over very thoroughly. This will give you a chance to correct any mistakes that could jeopardize your approval for the mortgage you want.

How do lenders figure out your credit rating? They usually assign you a score based on your credit report. There's no mystery to this. You can and should get the same copy of your report and your score by going to myfico.com. The web site also explains why you got the score you did and, if it's low, how to raise it. It also tells you what interest rate you can expect based on your score. This is a great planning tool that can enable you to get the home you want at the best terms possible.

What can you do to get approved? We know there's not much you can do to change the past, but there are some steps you can take regarding your employment and credit that will help you get approved for the mortgage you feel you can handle.

First, let's look at your employment situation. If you have been at the same company for five years and are getting ready to start your own business, it would be wise to postpone that move until after the purchase of your home. While you may have been preparing for this move and are certain of guaranteed success, from a lender's perspective you have gone from being Sally Stability to Wildcard Wally. By all means start that business for yourself, but wait until the dust settles on your home purchase. In the same vein, if you're planning on making a jump from one career to another, or going from one company to another, if possible don't do it at the same time that you're trying to get pre-approved for a mortgage. We realize that sometimes you have to make certain moves at certain times, but if you have control over timing, use it to your advantage.

On the other hand, you can use employment changes to your benefit. For example, let's say four years ago, your spouse, an engineer just like you, stopped working full-time to be a stay-at-home parent. Now, your child will be attending school full-time and, when the school year starts, your spouse is returning to a full-time position similar to the one she previously held. We understand that, depending on how far you are moving, you may want to settle into your new home before the school year begins. However, if you resist that urge until your spouse has resumed working, you may be eligible for a larger mortgage, making it possible for you to buy the home you really want.

As for your credit history, it may not be top-notch, but even if it's excellent, you can improve your chances of getting the mortgage you want by getting rid of as much of your present debt as possible. This is true because the fewer other bills you have to pay, the more that lenders see freed up for a mortgage payment. If you haven't established any kind of credit history, it may make sense to purchase items you were going to purchase anyway on credit and promptly pay the bill. One thing we strongly suggest is do not make any big-ticket purchases when you are applying for a mortgage. If your refrigerator stops working, we understand that you probably need an immediate replacement. However, hold off tying up funds that could be available as mortgage payments by buying that sailboat you've always dreamed of.

Where to go for pre-approval. OK, you say you're ready to get pre-approved for a mortgage now. Where do you go for that pre-approval? Banks, including savings and loans and some commercial banks, and credit unions are where most people go when they want to borrow money to buy a home. Mortgage companies, experts in getting loans from different sources, are also a popular choice. These lenders will calculate the amount of the loan, as well as explain the kinds of mortgages they can make available to you. It's a good idea to go through the pre-approval process with more than one lender because one lender's result may be a better fit for you than another's.

What will this cost you? Many lenders do not charge an application fee for pre-approval purposes. However, some do, so be certain to inquire. Once you make your final choice and actually apply for a mortgage for the home you're buying, you will, in all likelihood, have to pay an application fee at that point.

You can apply for pre-approval the old fashioned way, that is, in person and using the mail and fax machines, or in many cases you can apply and be pre-approved online. If you use the Internet for pre-approval, the turnaround time for your approval can be surprisingly quick.

Warning While you want to be pre-approved for the maximum amount you would be eligible to borrow, don't feel that you have to get a mortgage for that amount. This may sound like common sense, but if you find the perfect home for you and the mortgage you will need to buy it is below the amount you are pre-approved for, by all means, buy it. This is particularly true if the amount you're approved for is uncomfortable for you. Go with your instincts.

Also, keep in mind that real estate agents generally earn their money by getting a percentage of the cost of your home. Therefore, the more you pay for a home, the more money they make. If you are pre-approved for a specific mortgage amount, it's all the better for them if you use every dollar of it. Please remember their commission is involved, particularly if the amount of the mortgage you would need to buy a home seems high to you based on the numbers.