What’s mortgage pre-approval, and how to get one?

For first time homebuyers, the process of buying a home and the work involved can be overwhelming.

As if searching for a real estate agent and a home wasn’t already enough, they then also have to familiarize themselves with all the nuances of getting a mortgage.

 While the process can be quite stressful, there are several things one can do to ease a lot of that stress. One such thing is getting a mortgage pre-approval.

What is a mortgage pre-approval?

As you would guess, pre-approved simply means “approved” for a mortgage before you even start looking at homes. It entails doing a lot of the work associated with getting a mortgage upfront and saving the effort and time later. 

Why can’t I apply for a mortgage later?

You likely can. But chances are that your agent will ask you to get one before you even start looking at homes.

Even if he or she doesn’t (for some reason), home buying is a long process and involves accomplishing a lot of tasks.

After your offer on a home is accepted, there are so many things to get done – Mortgage application, inspection, appraisal, title insurance, finding a settlement agent, document review and closing. With so many tasks to be done, the whole process can seem very time-consuming. 

To reduce the effort, it is a very good idea to get approved for a loan beforehand. That not only helps you save time and effort later, it is a prerequisite, for reasons explained below.

Benefits of getting a mortgage pre-approval

• It saves you a lot of effort and time later when your offer has been accepted and you are busy doing the many other things involved with home-buying.
• When accepting an offer, sellers not only look at the offered price but often take into account the credit worthiness of the borrower. If you have a mortgage pre-approval, chances of your offer getting accepted are higher (vs if you don’t).
• Most real estate agents will ask you to get one so they know that you’ll indeed be able to close the transaction once the offer is accepted. It also helps them get a sense of the price of homes they should help you look for.

Is pre-qualification the same as pre-approval?

You may have heard of another term called pre-qualification. From the looks of it, it might appear as if pre-qualifying and pre-approval mean the same thing. In reality, they are quite different.

Pre-qualification is a process whereby a lender will ask you a few questions to determine up to what loan amount you’ll likely qualify for. It doesn’t typically involve much documentation and is solely based on the information you provide. It’s an informal determination and even if a lender pre-qualified you, you’ll be asked to go through the formal application process later.

Pre-approval, on the other hand, is a more rigorous process. It is a formal determination of your eligibility for getting the loan, the rate the lender will likely offer you, the loan amount and other terms of the loan. It requires filling out a complete loan application, going through a hard credit check and submitting all the supporting documents that a lender requires to approve a loan.

What do I need to do to get a mortgage pre-approval?

Most lenders in the US approve home loans based on guidelines provided by the two  Government-Sponsored Entities (GSEs): Fannie Mae and Freddie Mac. These two entities have very specific guidelines on how exactly a lender is supposed to approve a home loan. The guidelines are essentially like a flow-chart which the lender goes through to determine each individual’s scenario and depending on. It entails accomplishing the following steps:

  1. Mortgage Application

This is the first step in getting the pre-approval. Most lenders these days have an online application that you can fill and submit. This application typically asks for personal information, residential and employment history, income details, bank and retirement accounts, demographic details and real estate owned. 

It is a good idea to gather this info before you start an application. Once you have all the information in one place, filling out the application should be a quick and easy process.

  2. Income and Employment Documents

Depending on whether you are an individual who is a salaried employee or self-employed, the requirement for supporting documents can be quite different. The main goal is to ascertain if you have enough income to be able to make the monthly mortgage payments.

For salaried individuals, the supporting documents typically requested are W-2 forms for the last 2 years and most recent two months of pay-stubs. 

For self-employed individuals, the lender will typically ask for 2 years of tax returns, a Year-To-Date (YTD) Profit & Loss (P&L statement) and copies of business receipts.

  3. Asset Statements

Asset statements are statements of your bank accounts, individual retirement accounts, 401(k), brokerage accounts, etc. The main reason behind asking for proof of assets is for the lender to ascertain if you have enough funds to (i) Make the down payment; (ii) Pay for the closing costs associated with the loan; and (iii) Sufficient reserve requirements as required by the Fannie Mae, Freddie Mac’s automated underwriting review.

In cases where a mortgage applicant’s savings are substantial, liquid assets can be used in lieu of income to determine one’s eligibility.

  4. Credit Report and Financial Liabilities Disclosure

Almost all lenders will require a credit check before they approve a loan. The main idea behind this is two fold:

(a) To determine if a borrower has demonstrated the ability to make payments on his or her financial obligations in the past. Borrowers who have been diligent with their payments in the past have a higher likelihood of continuing to meet their obligations in the future as well. And hence they are more likely to be approved.

(b) The other information that a credit report contains is a list of borrower’s current monthly obligations and the associated payments. That can then be used to determine how large a payment can a borrower make for his monthly mortgage.

Full disclosure of liabilities is important for the key Debt-to-Income calculation.

  5. Verification of Employment

While pay-stubs are proof of recent employment, the bigger concern to a lender is a borrower’s ability to make the payments going forward. For that reason, many lenders not only ask for employment verification letters, they also do a verbal verification right before closing (or on the day of closing) to ascertain that the borrower is still employed and will be able to make those payments.

  6. Real Estate Owned

Lenders also want to know if there is any other real estate that the borrower already owns. Now, why is that needed? Well, the idea is that any real estate that a borrower owns has liabilities associated with it (i.e. monthly payment obligations). Those monthly obligations need to be taken into account when determining how much an individual can comfortably afford to pay for the new loan. These obligations include current mortgage payments, property taxes, insurance and HOA dues.

  7. Identity Verification

Identity verification is to ascertain the legitimacy of the borrower and to prevent possible fraud and criminal activity (for example: money laundering). Lenders can also ask for letters of explanation attesting that they did not take any loans recently, that are not shown on the credit report.

I understand the steps. What next?

Once you understand the steps involved, the next thing to do is to identify a lender where you can submit an application for pre-approval. When you search online, it’s still not easy to determine who the good lenders are and who you can trust with likely the biggest purchase of your life.

At Stem Lending, our goal is not just to provide great rates. An even bigger motive for us is to educate you as much as we can so you can make an informed decision. 

As is evident from our client testimonials, we feel confident of providing a great experience to you in your home purchase. Start right away at: stemlending.com/apply