Pre-Approvals

Buying a home is one of the most exciting milestones in life; however, before you start  looking at every house in search of your dream home, there is a crucial first step that can set you  up for a successful purchase: getting Pre-Approval. A Pre-Approval can help you understand  what you can afford and show sellers that you are a serious, well-qualified buyer. In this article, I  will explain what a Pre-Approval is, why it is important, and how the process works. 

A Pre-Approval usually comes in the form of a signed letter from your lender or  mortgage broker. The letter will tell the buyer, seller, and all realtors involved the following  information: the address of the property (if the buyer knows which property they would like to  buy), what type of mortgage will be used to purchase the property (whether that be conventional,  FHA, VA, USDA, etc.), the term and type of rate (fixed or adjustable rate), and the purchase  price that the borrower has been Pre-Approved for. Most Pre-Approvals have an expiration date  due to credit and income potentially changing over time (our expiration is after 90 days). If no  loan has been submitted after that date, the buyer will need to be reevaluated to receive an up-to date Pre-Approval. Also contained in the letter is the lender’s assurance that they have reviewed  the buyer’s credit profile, and pending any significant changes, the buyer will be able to get a  mortgage. (See the example Pre-Approval Letter at the end of this article.) 

Pre-Approvals are a very important aspect of the homebuying process. A Pre-Approval  signifies to the seller that you, the buyer, can afford the home and secure the proper financing for  the purchase. Without a Pre-Approval, the seller has no idea whether you can actually buy their  home, leading to the possibility of the seller rejecting your offer to purchase. In essence, a Pre Approval shows the seller that you are not wasting their time and that you have the means to buy  their home. 

Now, let’s turn to how the process of getting a Pre-Approval works. To start the process,  you will need to provide your lender with some basic information and documents. The required  documents may slightly differ depending on your type of income (self-employed, retired, or W 2). The items that lenders need, regardless of income type, include: a copy of a valid photo ID,  Social Security Number, two years of residence history, your down payment amount, and an  anticipated purchase price (although this is not required, it can be helpful). Regarding specific  income types, let’s begin with the most common—W-2 income. For W-2 workers, we will need  your last two years of W-2 forms from all employers and your most recent 30 days of pay stubs.  For self-employed workers, we will need your last two years of individual tax returns and your  last two years of business tax returns. For those who are retired, we will need an annual or  monthly statement that shows how much you receive (for example, a Social Security Award  letter) and/or a monthly or quarterly statement from your individual retirement account (for  example, if you have an IRA, it would be the last account statement you received). 

Once you’ve provided your lender with the required documents and information, they  will review your credit profile. The first thing they will look at is your income. When assessing  income, lenders calculate based on what you earn monthly. The reason behind this is that  mortgage payments are typically paid monthly, so we need to determine that on a monthly basis,  you can afford the mortgage payments. 

Next, the lender will pull your credit report, which will show them how much you spend  each month on debt payments and provide a complete picture of your credit history. (At Select  One, we can do a soft pull, which shows all the same information as a normal credit pull but does  not show up as an inquiry on your credit report, thus not affecting your credit score.) These two pieces of information help us in two key ways. First, your credit score tells us what kind of loan  you best qualify for (each type of loan has slightly different requirements). Beyond determining  which loan program you qualify for, your credit score also affects the interest rate you’ll receive.  The higher your credit score, the lower your interest rate will be. 

We then look at your monthly debt to calculate your Debt-to-Income ratio (DTI). Your  DTI is calculated by taking your monthly debt payments (including the proposed mortgage) and  dividing them by your monthly income. There are two types of DTI we evaluate: Front-End DTI  and Back-End DTI. The Front-End DTI refers to your housing expense DTI, where we only  consider the monthly expenses you must pay to keep your home, including mortgage payments,  homeowner's insurance, property taxes (even if you choose to pay property taxes annually rather  than escrowing), and any homeowners association or condo association dues. The Back-End DTI  includes the total monthly payments, including the housing expenses above, along with all other  debts appearing on your credit report. DTI is important in evaluating a buyer because it helps us  understand what kind of house you can afford. Depending on the loan type, there are various DTI  limits. For conventional loans, we only look at the Back-End DTI, and the limit is 45%-50%  (depending on your credit score). For FHA loans, both Front-End and Back-End DTI are  considered; the Front-End limit is 43.9% and the Back-End limit is 56.99% (again, these depend  on your credit score). For USDA loans, the Front-End limit is 29% and the Back-End limit is  41% (also depending on your credit score). A note on VA loans: there are no set DTI limits or  credit score requirements. 

Once the lender has reviewed your credit score and DTI, they will determine if you can  be Pre-Approved. If everything looks favorable, they will issue you a Pre-Approval letter. If the  lender cannot issue a Pre-Approval, they will provide guidance on how you may be able to  obtain one. This could include suggesting you consider lower-priced homes, pay off debt, or wait  to build your credit score. 

One final note on Pre-Approvals: if you have received a Pre-Approval, it is crucial that  you avoid taking out other loans, opening new credit cards, or changing jobs. Doing these things  could significantly alter your credit profile and may result in your mortgage being denied. 

I hope this article has helped you understand the Pre-Approval process and its  importance. As you move through the process, don’t hesitate to ask your lender any questions  you may have. A good lender will be more than happy to answer your questions promptly and  honestly.