Shopping idly for a home may be pleasant, but serious home buyers need to start the process in a lender’s office, not at an open house. As a potential buyer you benefit in several ways by consulting with a lender and obtaining an approval letter.
First, you have an opportunity to discuss loan options and budgeting with the lender. Second, the lender will check your credit and alert you to any problems. Third, you will learn the maximum amount you can borrow, which will give you an idea of your price range. However, you should be careful to estimate your comfort level with a given house payment rather than immediately aiming for the top of your spending limit. Lastly, most home sellers expect buyers to have a pre-approval letter and will be more willing to negotiate with you if you have proof that you can obtain financing.
Pre-Qualification or Pre-Approval?
You’ve likely heard the term “pre-qualification” used interchangeably with pre-approval, but they are not one and the same. With a pre-qualification, you provide an overview of your finances, income and debts to a mortgage lender who then gives you an estimated loan amount. However, the lender doesn’t pull your credit reports or verify your financial information. Accordingly, pre-qualification is a helpful starting point to determine what you can afford but carries no weight when you make offers.
On the other hand, a pre-approval involves filling out a mortgage application and providing your Social Security number, so a lender can do a hard credit check. A hard credit check is triggered when you apply for a mortgage and a lender pulls your credit report and credit score to assess your creditworthiness before deciding to lend you money. These checks are recorded on your credit report and can impact your credit score. On the other hand, a soft credit check is when you pull your credit yourself, or when a credit card company or lender pre-approves you for an offer without you asking.
Also, you’ll list all your bank account information, assets, debts, income and employment history, past addresses, and other key details for a lender to verify. Why? Above all, a lender wants to ensure you can repay your loan. Lenders also use the provided information to calculate your debt-to-income and loan-to-value ratios, which are important factors in determining interest rate and ideal loan type.
Being pre-approved for a mortgage by a mortgage banker or broker can be a good negotiating tool. For one, a seller might be inclined to accept a slightly lower offer if it comes backed by a solid pre-approval. This is especially important when a competing offer comes from a buyer who hasn’t yet applied for a mortgage. THe process of obtaining a pre-approval prior to making a home search also gives a buyer a realistic idea of what she can afford.
The first step in the process of obtaining a mortgage pre-approval is to apply to a lender or a mortgage broker. The buyer should have an idea of the size of the loan being contemplated, and the lender or the broker will work with the applicant to determine just how much home he can afford. Prospective buyers should always try to avoid the temptation to stretch a contemplated payment too far, thereby taking on more loan than can easily be afforded.
The pre-approval processes
The pre-approval process can start anywhere up to 120 days before you want to buy a home, depending on how long the lender’s pre-approval is guaranteed. It’s the first step to getting a mortgage, and although it typically doesn’t take that long to complete, another benefit to doing it early in the process is that you’re not simultaneously dealing with offer negotiations, when every moment can be crucial. For a mortgage pre-approval, you must provide supplemental documentations proving your income, the source of your down payment, and your assets and liabilities. The lender will also look at your credit report to determine your credit-worthiness.
According to BMO, you (and other applicants, if more than one person is applying) will need to provide the following information:
- Photo ID
- A record of employment income such as a pay stub, T-4 slip or a personal income tax return (if you are self-employed, at least two years of Personal Income Tax Returns and Financial Statements)
- A letter from your employer stating the length of employment and current salary
- The account numbers and locations of your bank accounts and investments
- Proof of assets, such as
- Investments and interest income
- Retirement savings accounts
- Other real estate holdings
- Proof of liabilities, such as
- Existing mortgages
- Credit card balances
- Car loans
- Student loans
- Lines of credit
- Co-signed or guaranteed loans
- Child support