Mortgage Pre-Approval 101
Want to get pre-approved for a mortgage but don’t know where to begin? This easy-to-follow guide covers everything you need to know about mortgage preapproval. Start from the beginning or jump in wherever you are to continue!
Components of a Mortgage
Simply put, a mortgage is a loan secured by real property and paid in installments over a set period of time. The mortgage secures your promise that the money borrowed for your home will be repaid. These are the components of a mortgage:
1. Mortgage Approval:
Qualifying for a mortgage requires meeting a pre-determined set of guidelines established by a lender, which may include credit history, income, employment, and assets.
In addition to personal qualifying factors, a property must also meet certain standards set by lenders before a borrower can obtain a mortgage loan secured by real estate.
2. Mortgage Payments:
On a traditional 30 or 15 year fixed rate mortgage program that involves principal and interest, each payment made is divided into two parts (we’re not including taxes or homeowners insurance as part of this discussion):
- The first part of the mortgage payment, which is commonly referred to as principal, goes to paying down the initial amount borrowed.
- The second part is the interest paid for the money borrowed to purchase the property.
The amount paid in interest decreases each month, as the amount paid towards the principal balance increases. This apportioning is referred to as amortization.
Other types of mortgage payments available can include options for paying interest only or a teaser rate.
Either way, it is extremely important to have a solid understanding of the full payment and terms before moving forward with a particular option.
3. Mortgage Programs:
Mortgage Programs come in many different types of flavors and colors depending on the down payment and/or monthly budget a borrower has been approved for. There are also federally insured mortgages, such as FHA or VA loans, which have more flexible qualifying guidelines.
4. Closing Costs/Fees
The actual cost of obtaining a mortgage mainly depends on whether or not the borrower is paying points for a lower mortgage rate. In some cases, there are also other loan processing and underwriting fees associated with the work involved in the transaction.
Fortunately, there are several consumer protection policies implemented by the government to help borrowers understand their options during the initial mortgage pre-qualification process. However, please keep in mind that there may be other closing costs not associated with a mortgage or real estate transaction to be aware of. Appraisal, pre-paid property taxes, insurance and interest, HOA dues, and inspections are a few additional out-of-pocket expenses you should budget for.
5. Mortgage Rates:
While mortgage interest rates may change several times a day, there are a few market factors you can pay attention to which may impact your final payment.
Whether you’re shopping for the best rate or trying to determine the difference between the Note Rate and APR, it definitely helps to understand what questions to ask a mortgage lender about your specific loan scenario.
Pre-Approval vs. Pre-Qualification
As a Lender, we get asked numerous times the difference between a mortgage pre-approval and pre-qualification.
Mortgage Pre-approval is written documentation that shows you have the support of a lender who is willing to finance you. It means your loan documents have been reviewed. Based on your income, debt ratio, and savings, you are preapproved for the dollar amount you are eligible to borrow. Now you can shop around for houses that fit into that loan amount category.
Mortgage Pre-qualification is the starting point in your search for mortgage financing. A quick snapshot is taken which includes income, existing debt, savings, length of employment, etc. All of these factors will then be analyzed to determine your loan eligibility.
Even though many lenders are still quoting quick 10-minute prequalifications over the phone or online, a true mortgage approval that holds any weight is one that has been issued after a review of all the necessary documents
With a constant stream of new lending guidelines, volatile mortgage rates, and tightening regulation from Washington, very few real estate agents will show new homes to a first time home buyer without a pre-approval letter.
A Pre-Approval Letter will help you in three ways:
- It lets you know how much mortgage you can qualify for
- It gives you an estimate of what your total housing payment would be
- Submitting a strong “Pre-Approval” letter with a purchase offer will give the seller more confidence about your ability to complete your end of the agreement
It’s obviously a good idea to get your paperwork prepared ahead of time so that the pre-approval process is as thorough as possible.
In order to get a pre-approval letter, you’ll start by filling out a loan application and submitting a few documents for the loan officer and/or underwriter to review.
What You Need for Pre-Approval
These are common loan pre-approval documents:
Income / Assets for Wage Earner:
- Last 2 year W2s and Tax Returns
- 2 most recent Pay Stubs
- 2 most recent Bank Statements, 401(K), Liquid Assets, Investment Accounts
Income / Assets for Self-Employed:
- Last 2-year Tax Returns – Business and Personal
- Last Quarter P&L Statement
Letter of Explanation For:
- Employment Gap or New Line of Work
- Late Payments / Judgments / Bankruptcy on Credit Report
- Bankruptcy Discharge
- Child Support Documentation
- Lease Agreements (If you own other rental properties)
- Mortgage Payment Coupons (If you own other real estate)
- Immigration status in the U.S. (If not a citizen)
To get Pre-approved with Arcus Lending, start by completing the loan application on the secured site or by downloading the app.
Most borrowers also want an opportunity to learn more about the loan officer before digging up all of these personal documents. Spend 15 minutes on the phone asking the loan officer to explain how mortgage rates work, quizzing them on some basic industry vocabulary or just to see if they know what to prepare your agent for ahead of time. The Q&A session can be more than just a lender qualifying you, as long as you’re prepared to ask the right questions.
Either way, you’ll definitely want to have the above list of approval documents ready once you’ve decided on the right loan officer that you trust will meet your expectations.
How Much Mortgage Can You Afford to Borrow?
This is typically the number one question mortgage professionals are asked by new clients. It is of critical importance when considering mortgage financing: There is sometimes a difference between what a client ***can*** borrow and what they ***should*** borrow. In other words, what makes for a comfortable long-term mortgage payment?
The quick answer: If we’re simply considering the financial math, lenders will calculate your Debt-to-Income ratio and generally allow for up to 43% of your gross income to be used for all consumer related debts combined including your new housing payment.
Note: Debt-to-Income ratio is calculated by dividing the total monthly debt payments by the total gross monthly income.
Sample Mortgage Scenario:
Let’s use a gross monthly income of $3000 and a qualifying factor of 40% Debt-to-Income Ratio: $3000 multiplied by .4 (40%) = $1,200 max monthly mortgage payment
This means that your mortgage payment (Principal, Interest, Taxes, Hazard Insurance) cannot exceed $1,200 a month.
“Ballparking” a Qualifying Loan Amount:
Simple step: We use a safe average of $7 per month in payment for every $1000 in purchase price so –
1. $1,200 a month divided by $7 = $171.40
2. $171.40 multiplied by 1000 = $171,400 loan amount.
Remember, these are average ratios and guidelines set by most lenders for common mortgage programs
Keep in mind, while most consumer debts are listed on a credit report, there are some additional monthly liabilities that may contribute to the overall qualifying percentages as well.
Regardless of how your personal income and credit scenarios factor in, it is important to consider your overall budget when trying to determine how much of a mortgage you should qualify for.
Other items to consider in your monthly budget:
- 1. Confirm all debts are taken into account
- 2. Any private notes or family loans
- 3. Short-term expenses – medical, auto repairs, travel, emergencies
- 4. Plan on additional expenses for the home such as water, electricity, maintenance, etc
- 5. Keep a cushion for savings and financial planning.
There is a big difference between a Pre-Approval Letter and a Mortgage Approval Conditions List.
The Pre-Approval Letter is generally issued by a loan officer after credit has been pulled, income and assets questions have been addressed and some of the other initial borrower documents have been reviewed. The Pre-Approval Letter is basically a loan officer’s written communication that the borrower fits within a particular loan program’s guidelines
The Mortgage Approval Conditions list is slightly more detailed, especially since it is usually issued by the underwriter after an entire loan package has been submitted.
Even though questions about gaps in employment, discrepancies on tax returns, bank statement red flags, and other qualifying related details should be addressed before issuing a Pre-Approval Letter, the final Mortgage Approval Conditions list is where all of those conditions will come up. In addition to borrower related conditions, there are inspection clarifications, purchase contract updates, and appraised value disputes that may show up on this list. This will also list prior to doc and funding conditions so that all parties involved can have an idea of the timeline of when things are due.
What is Included in a Pre-Approval Letter?
Getting a Pre-Approval letter for a new home purchase is mainly to let everyone involved in the transaction know what type of mortgage money the buyer is approved to borrow from the lender.
The Pre-Approval letter is based on loan program guidelines pertaining to a borrower’s DTI, LTV, credit, property type, and immigration status
Loan-to-Value (LTV) is calculated by dividing the loan amount by the lower of the Sales Price or Appraised Value on a Purchase, or Appraised Value on a Refinance.
A complete Pre-Approval letter should let the borrower know the exact terms of the loan amount, down payment requirements, and monthly payment, including principal, interest, taxes, insurance, and any additional mortgage insurance premiums. However, note that the interest rate is not locked at the time of pre-approval. The rate is locked only after your offer is accepted and you get into contract.
7 Items to Look for in a Pre-Approval Letter
One of the most important items to remember when looking into financing is that there is sometimes a difference in the amount a borrower can qualify for vs. what’s in their budget for a comfortable and responsible monthly payment.
7 Items to Look For in a Pre-Approval Letter
- Loan Amount– Base loan amount and down payment
- Status Date and Expiration Date – Most Pre-Approval letters are good for 90 days from when the credit report is run. However, at Arcus Lending we are flexible on the expiration dates of our preapproval as long as nothing has changed on your credit profile.
- Mortgage Type – FHA, VA, USDA, Conventional, Jumbo
- Term – 30, 20, or 15 year fixed, ARM (Adjustable Rate Mortgage); if ARM, 5, 7 or 10-year initial fixed period
- Occupancy – Owner Occupied, Secondary Residence, or Investment Property
- Contact Info – Lender’s Name and Address
- Conditions – Document requirements prior to Approval
To get Pre-approved with Arcus Lending, start by completing the loan application on the secured site or by downloading the app