You’ve been working hard, love your city and you are ready to buy a house.
You think you do, anyhow. But can you afford a house? Will you be approved for a mortgage? Before you start looking at houses or even talk with a realtor, you want to determine if you are able to get a home loan.
There are a couple of terms out there you may have heard: mortgage pre-qualification and mortgage pre-approval. What’s the difference?
A loan pre-approval means that the lender decides you are, in fact, a good candidate for a loan. Not only that, but they will let you know how large of a loan you may be approved for.
However, loan pre-approval is not a commitment from the lender and doesn’t state interest rates and terms.
Loan pre-qualification is basically just a conversation with a lender to get an estimate of what you might be able to afford. This can be done over the phone and without any paperwork.
This is of no real value to you unless you are unsure if you even come close to qualifying for a mortgage.
How to get pre-approved
Before you make an offer on a house or even start looking, you will need to gather a number of documents in a folder. You will need these same documents again later, so keep the folder handy.
Be prepared to provide your addresses and dates you resided there for the past 2 years, including your landlord’s name and address if applicable. We have even been asked to verify our addresses for up to 10 years.
Pay attention to this. The banks pull their information from various reporting agencies and the information is not always correct. At one time, the information the bank received indicated we still owned our previous house.
Proof of income
You will be asked to provide your last two years of NOA’s and tax returns. The lender will also want copies of your most recent pay stubs and proof of any additional income.
Some lenders may have you sign a document giving them permission to obtain a copy of your tax returns directly from the CRA rather than you providing a copy. Either way, have copies ready.
Your debt-to-income (DTI) ratio should be below 40%, including mortgage and insurance payments.
What is DTI? You add up all of your monthly income, then subtract all of your monthly debts (loan payments, minimum credit card payments, housing, etc.). Your debts should total less than 40% of your income.
So, if your income is $10,000/month, you want less than $4000 in debt payments each month.
The lender will also check on your employment status. You want to ensure you have 2+ years at the same job or in the same field of work. Your employer(s) will be called to confirm this information.
Proof of assets
The lender wants to know that you are able to provide a good down payment. So, you will need to provide copies of recent banking account statements, investments or anything else you will use to draw funds from for the down payment and closing costs.
Note that for conventional loans, you’ll need a down payment of 10-20%.
In order to be approved for a home loan, you need good credit. The lender will ask for your social security number and permission to pull your credit report. Lenders seem to want a score of at least 650. You will need a credit score above 740 to get the best rates on a mortgage.
Note that if you are buying a house with a partner or spouse, the lower score is what is used. So, if only one of you has good credit, you might try and qualify only using information for the person with the better credit.
What to do once you are pre-approved
If you are pre-approved, you will get a letter saying so along with a good-faith estimate of loan terms. At this point, you might even be able to lock in rates for a set period of time. Save this and also give your realtor a copy of the letter.
Check with your lender, but the pre-approval is usually good for 60-90 days. Beyond that time, statements and information will need to be updated.
A word of caution
In our experience, the lender will most likely pre-approve you for a loan amount higher than what you anticipated or feel comfortable taking. Sit down and figure out what size of the loan you are comfortable with and let your realtor know.
If you are approved for a $500,000 loan but really are only looking for $250,000, make sure you are looking at houses that fit that lower limit. You do not want to take out a mortgage so large you are eating ramen for the next 20 years and can’t afford a new water heater when it’s time to replace it.
After mortgage pre-approval and before closing
After you obtain your pre-approval letter, you can start looking at houses. This is when you want to protect your finances and credit score.
Do not make any major purchases
You might want to go start buying new large appliances or furniture now, but hold off until you have house keys-in-hand. These large purchases send a worrisome signal to the lender and you may then not get final approval on your loan.
Do not change banks or apply for new lines of credit
Again, changing banks or applying for new lines of credit is a red flag for lenders at this stage. Just don’t do it.
Enjoy the process
Getting a mortgage pre-approval will help clarify what you can afford (or, what the bank thinks you can afford). It also gives more weight to any bids you submit to sellers.
Once you have an accepted offer, dig out the folder you put together earlier, and formally apply and finalize the loan terms. When the final documents are signed and you have your new home, you can celebrate.
At One Mortgage Group, we always provide our clients with the lowest interest rates and the highest level of advice. Please feel free to contact us, anytime.