Before getting too serious about house shopping, most people want to be certain they will qualify for adequate home financing in order to know how much house they can afford and what the total monthly costs will be once they move in.
Lenders help would-be homeowners in this process in three ways; pre-qualification, pre-approval and, once you have made an offer on a home, the loan commitment.
And while these two terms may seem the same to a first time homeowner, there are differences of which you should be aware when shopping for a home mortgage. Also, it’s important to know that pre-qualification or pre-approval doesn’t mean that your lender is obligated to provide you with the loan funds?
Huh? If, you ask, I’m pre-approved; doesn’t that mean I’m guaranteed the loan? Well, not quite. The loan qualification closing process involves many steps and guidelines before a lender funds a loan. And, since some of these involve the property itself and your income and other pertinent financial factors at the time of closing, a pre-qualification or pre-approval doesn’t guarantee you will get the loan.
So, you ask, why do I need to get pre-qualified or pre-approved if it doesn’t guarantee loan funding? The home loan process is actually not that complicated once you understand the steps and what’s required. So, let’s start by defining these terms a little more clearly, since even real estate agents often confuse them!
Home Loan Pre-Qualification
The home loan pre-qualification process doesn’t involve an in depth analysis of your credit report or a detailed look at your true ability to buy a home.
You can get pre-qualified by a real estate agent, mortgage broker or loan officer. In fact, you can even do your own pre-qualification! Really, the term simply means that someone has looked over your income and expenses and used a debt-to-income ratio formula to determine an approximate loan amount and terms for which you are likely to qualify.
While not required, it’s a good idea to perform a simple pre-qualification yourself before looking at homes so you have an idea what price range you can afford. The pre-qualification process doesn’t tell you what interest rate and type of loan you can get.
The other reason this is a good first step is that it forces you to gather and write down much of the basic information your lender will ask you when you start shopping for a loan; a loan officer will ask you about your income, assets, debts and projected down payment in order to ascertain what type of loan you’d likely qualify for. The process only takes a few minutes to complete.
Home Loan Pre-Approval
Once you start looking at new homes or shopping for a resale home, you will want to talk with your lender about pre-approval. Getting pre-approved for a mortgage involves the lender looking closely at your credit report, assets, debts and income to determine whether you qualify for a loan.
Your lender can then let you know how much you will be able to borrow, what loan programs, approximate monthly payments, interest rates and so on you will be offered.
Once you are pre-approved you can shop for a home, confident about your buying power; but you still aren’t guaranteed that the lender will approve your home loan.
The pre-approval process is more involved than pre-qualification and typically requires an appointment with your mortgage broker or loan officer.
At this stage in the loan process, your lending institution will gather all the information required in order to make you a loan; they will check your credit report and some lenders charge a small fee at the time of the appointment.
Be sure to have pertinent documents with you for the pre-approval meeting, including:
- Your driver’s license or other official picture identification
- A copy of your most recent bank statements, including your regular checking account and any money market, savings, IRA or other retirement accounts, stocks, bonds and mutual funds you own
- Your most recent W-2 or IRS tax return if you are self-employed
- The most recent month’s paystub(s) from your employer
- An application fee may also be required, depending on the lender
Once the pre-approval process in complete, you will receive a “good faith estimate” (GFE). This document let’s you know the approximate terms your lender is willing to offer you, including the interest rate, loan type (fixed rate, adjustable rate, etc.) and your projected closing costs.
While the pre-approval process takes time, you should complete it with several lenders in order to truly compare offers; without a GFE you won’t truly know the differences in the terms each lender offers you.
To negotiate the best possible interest rate, closing costs, or obtain lender-paid private mortgage insurance , you need to get multiple lenders compete with each other. Also, by looking at several GFEs, you can spot fees and charges that one lender may charge while another does not.
You don’t need to worry about your credit score being affected by making several loan applications; the credit scoring process recognizes that multiple checks made in a short time period as a normal part of the loan-shopping process.
Remember; pre-approval does not mean the lender is guaranteeing you the loan; it means that you are likely to be approved if all goes well … meaning the home you want to buy appraises as expected, has clear title and you provide proof of insurance and that nothing happens to your income or credit score in the mean time.
Home Loan Commitment
Since both you and the home you are purchasing must qualify in order for a lender to make your home loan, loan commitment actually comes fairly late in the home financing process.
The home appraisal must meet the lender’s guidelines, which generally stipulates that the home must appraise at amount that is equal to or higher than the sales price.
Lenders consider other factors related to the home besides just the price and appraised value. They also want to see that the property would sell reasonably quickly in the event you default on the loan and they have to foreclose.
Lenders also want to be assured the home and property is in good condition. If, for instance, the appraiser notes something like a crack in the foundation or apparent leaks in the roof, the lender may require further inspections.
Additional Loan Commitment Requirements
The title search must indicate that the home has clear or “cloud-free” title, meaning it has no outstanding liens that will not be removed at closing, no right-of-way issues, pending lawsuits or other issues. Some lenders will also check your credit report again prior to closing to be sure nothing has changed for the worse.
You lender will also require proof that the home will be insured as soon as ownership transfers to you, which you can obtain from your insurance agent or company. Flood certification and other documentation may also be required.
A loan commitment letter is issued only when the lender is certain it will fund your loan; so if you your purchase offer specifies a loan commitment date, be sure it provides adequate time of time to meet the lender’s requirements.
If your contract has a commitment date, which is often the case, the seller may demand to see written proof that your lender has issued the loan commitment as soon as the date has passed.
Ask anyone who tries to insert an early commitment date in your contract why it is being requested; often “contingent” sales involve such clauses since the seller may need funds from the sale in order to fund another loan against another property they are buying.
You don’t want to find yourself in default of your purchase agreement in the event your lender takes longer than you expect to issue a loan commitment.