Buying a home is often the most expensive purchase most Americans will ever make. It’s also one of the most complicated. The first step many home buyers make is often to contact a realtor to begin looking at homes. However, the search for your Dream Home should begin with the home loan pre-qualification and pre-approval. While sometimes used synonymously, these are two distinctly different documents.
The pre-qualification process is typically the most basic and easy to do. If you’re not sure if you can financially afford a mortgage or are several months away from being ready to purchase a new home, this is a good place to start. Getting pre-qualified is usually an informal process that you and your bank or lender go through together. A credit report does not necessarily have to be pulled during a pre-qualification. In many cases, the lender will ask questions about your income, debt, finances, and other expenses that could affect your ability to qualify for a home loan. The lender will then take all of this information and come up with a rough estimate of what you would be able to afford. With this information in hand, you will have a better idea of the price of home to stay within and can begin working with a REALTOR® to look at homes within your price range. If you are already certain of the timing and amount you wish to borrow, you can skip the pre-qual stage and move directly to getting pre-approved.
Now you’ve been working with your real estate agent for awhile, gone through open houses, and looked at enough homes that you’ve started to give each of them a nickname to remember which is which. At this point, you might be narrowing your list down and still actively looking, but you have a pretty good idea of when you want to move and where you want to live. Queue the pre-approval.
Before going back to the lending company, you might want to do a little prep work on your end. We suggest the following:
- Request Your Free Credit Reports – every American is entitled by law to pull their credit reports once every 12 months from each of the 3 major credit reporting agencies: Equifax, Experian, and TransUnion. Use these reports to look for any accounts, charges, collections, or delinquent payments that do not look accurate. If something is fishy, submit a dispute with the reporting agency (or all three) in order to remove the error from your credit report. These can make or break your chances of getting pre-approved for a home loan, so don’t leave it to chance!
- Calculate Debt-to-Income Ratio – this is simply the sum of all monthly obligations to debtors, such as credit cards, auto loans, and student loans compared to y0ur income. There are several free tools you can use to quickly find out what your DTI ratio is. Typically anything less than 30% is viewed as ideal.
- Get Your Financial Information – being prepared before you walk into your bank will save you time and make you look like a pro. Make sure you have your (and your co-borrowers, if applicable) Social Security card, W2’s, 1099’s, current addresses, and employment information. You’ll also want to have your banking and investment accounts handy as well. 401k or IRA account? This will help show the lender that you have assets outside of a traditional savings or checking account.
- Do Your Research – ask around and see which lenders are offering the best rates and service. Your REALTOR® will be a treasure-trove of information and should be able to suggest at least a few lenders they have personally done business with in the past. Don’t put all your eggs in one basket. Reach out to more than one or two lenders for rates and pre-approvals. In many markets, banks will want to earn your business.
You were previously pre-qualified, but now you’re ready to get pre-approved. Another visit – or in some cases, a phone call – back to your lender, and you can get pre-approved for a home loan. This is the formal process of asking the bank to give you money to buy your Dream Home. The bank will take all the information that you gave them during the pre-qualification phase, update anything that needs to be updated, and pull your credit report. Based on your credit history and all your income, assets, and debt, the bank will make a determination on your credit worthiness and the amount and rate in which you qualify. The pre-qualification letter is what you will bring to your real estate agent and sellers to show you’re serious and able to stand behind your offers! The final paperwork will still have to go through a process called underwriting, where the accountants within the lending company go through your financials to ensure the risk of lending the money (based on your history) is lower than the value of the home, or collateral. However, in many cases, once pre-approved, buyers are ready to start making offers, and are one step closer to finding the perfect home.