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One of the most important steps, and usually the first, during the home buying process is obtaining financing. There are many different types of mortgages available. Each mortgage product varies from the amount of money needed down to the acceptable debt-to-income ratios and everything in between. When buying a home, it’s important for a buyer to know for certain, what the best type of mortgage product best suits their needs. There are even loan programs available for buyers who don’t have any money!
How do you go about knowing which type of loan is going to be the best for your situation? The answer is simple, getting pre-approved for a mortgage! There are many buyers out there who don’t understand why it’s important to get a pre-approval. In fact, many of them believe they don’t need a mortgage pre-approval before looking at homes. This is absolutely wrong, you would be so disappointed if you found your dream home only to lose it to another buyer because you were not pre-approved and someone else was.
When and why should you have a pre-approval for a mortgage? Below is a detailed explanation not only on when you should obtain a mortgage pre-approval but also many reasons why it’s extremely important to have one in hand before buying a home.
Pre-Approval Versus Pre-Qualification
There are some people that believe a pre-approval and a pre-qualification are the same and also some lenders who use the two interchangeably, they are not. They are actually very different and it’s important to understand what the differences are when buying a home.
What is a Pre-Approval?
A mortgage pre-approval is when a lender gives their written commitment to a potential borrower. The mortgage pre-approval process is one in which a lender will obtain from the potential borrower their bank statements, tax returns for the past several years, verify their employment, and pull a tri-merge credit report. This process does not have to take a substantial amount of time, however, does take a little more time than a pre-qualification, however, the extra time is time well spent.
It’s important to understand once a mortgage pre-approval is issued, there are still a handful of conditions that must be met before the lender is going to release the funds. The most common condition in a mortgage pre-approval is that the buyer finds a property and a satisfactory appraisal is done on the property. This means the property must be worth what the buyer and seller agree to and there are no bank required repairs. Other possible conditions in a mortgage pre-approval can include an acceptable homeowner insurance binder, continued creditworthiness, and in some cases, depending on the financing, proof of an acceptable home inspection.
What is a Pre-Qualification?
A mortgage pre-qualification can be best described as a prediction on the amount a buyer can borrow. In many cases, a pre-qualification is only as good as the piece of paper it is written on. Many lenders will ask a potential borrower about their incomes, debts, and other assets and use what they are told to issue a pre-qualification. Some lenders will pull a credit report, but some will not. This often can lead to surprises in the future once a buyer goes to formally apply for their mortgage.
When & Why Should You Get Pre-Approved for A Mortgage?
The answer to when you should get pre-approved for mortgage is simple, before you begin looking at houses. As mentioned above, many buyers don’t understand why this is important. Below are several reasons you will be glad you obtained a pre-approval for a mortgage before looking at houses!
Correct Potential Credit Problems
It’s not unusual for a potential buyer to not know what their credit score is, especially first time buyers. It’s also possible and common that a buyer isn’t aware of problems with their credit. The most common problem with a potential buyer’s credit is their score. There are minimum credit score requirements that each lender has for each one of their loan products.
Another common credit problem is an error with a buyer’s credit. Most people don’t monitor their credit report. It’s very possible for a buyer to have an error on their credit that is really not their credit problem. The process to get errors removed from a credit report can include sending letters to the creditor and the credit bureaus. It can sometimes take a couple of months for it to get corrected on your report and for your score to be readjusted.
No one likes to be disappointed or a disappointment. The same goes for someone who is purchasing a home. Another very important reason why a pre-approval should be obtained before looking at homes is because it can eliminate disappointment. Unfortunately, there are many real estate agents who show houses to a buyer even though they or the buyer, have no clue whether they can afford a home or not. This is a disservice to a buyer more than anybody else.
Why is this a disservice to a buyer? The fact of the matter is, a buyer can “fall in love” with a home, submit a purchase offer, and find out once they speak with a mortgage lender that they cannot obtain that home due to credit problems or because of other reasons. This understandably can leave a buyer upset, heartbroken, and disappointed! This can all be avoided by having a mortgage pre-approval before looking at homes.
Understand All of The Costs to Buying A Home
There are many costs associated with buying a home. It’s not as simple as a 3% down payment on a home. By getting a pre-approval, you will have a very strong understanding what costs you should expect when buying a home, so there are no surprises. The first thing you will learn when buying a home, is that everybody must get a “piece of the pie.” Typically, when buying a home, you have to pay a full year’s real estate tax, an entire year’s homeowners insurance, and many miscellaneous costs.
Bottom line get pre-approved so you have a full understanding how much money you will need to close on your dream home, who you will be paying these costs too, and why you are paying these costs.
Self Employed or Commission Based Buyers
If you are self-employed or are considered an independent contractor, getting a pre-approval is extremely important to do before looking at homes. There are many rules that apply to those who are self-employed versus those who are an employee of a company. Several years back, there were lenders who allowed self-employed purchasers to obtain a “no-doc” or no-documentation loan, which allowed a buyer the opportunity to purchase a home without providing all the necessary documentation that is required by lenders now-a-days. The days of “no-doc” loans are gone. If you are a self-employed buyer, you will need to provide at the very least, 2 years tax returns.
Does your income heavily rely on commission? If so, like a self-employed buyer, there are different requirements that a lender will have. Often lenders will require 2-3 years proven history showing the commission amounts earned is consistent. Normally a lender will take the 2-3 years history and average them out. For example, if a buyer has a sales position and they have a three year commission history of $100,000, $200,000 and $150,000, the will likely use an average expected commission income of $150,000 or less. A lender wants to be comfortable that the commission income is obtainable, year after year, before approving the loan.
Depending on the real estate market and the time of the year you are looking to purchase a home, it’s a strong possibility that a home will have multiple offers. Another reason to get a pre-approval for a mortgage is the advantage it can give to a buyer when in a multiple offer situation. A pre-approved buyer is likely to win in a multiple offer situation against a buyer who only has a pre-qualification letter, assuming the majority of the other terms in the purchase contract are fairly similar.
Any real estate agent who tells you that a pre-qualification letter is as good as a mortgage pre-approval is not telling the truth or doesn’t understand the difference them self! A great sellers real estate agent is going to advise their client that a pre-approved buyer is a much stronger candidate than a pre-qualified buyer.
Recently one of our sellers had multiple offers on their home. The pre-approved buyers offer was $2,000 less than the pre-qualified buyers offer, however, the seller ended up selecting the pre-approved buyers offer even though it was less money due to the fact they felt they were more serious about buying a home than the pre-qualified buyer! This is only one situation when this happened, but it happens more often than most buyers believe, which is why being pre-approved can be the difference between losing or winning in a multiple offer situation.
Real estate transactions generally take 30-45 days from contract to closing. The key word being “generally.” One important thing to understand when buying a home is contract dates may not always be met 100% of the time on the target! A pre-approved buyer will be able to close quicker than a buyer who is pre-qualified.
The main reason a quicker closing can happen is because most of the background checking has been completed by the lender prior to obtaining an accepted offer on a property. Once a pre-approved buyer is under contract and any inspections are completed, the lender can order the appraisal on the property. As a pre-approved buyer, you will have already filled out the mortgage application, given the past few years tax returns, and your credit has been reviewed.
As you can see, there are many reasons why having a mortgage pre-approval is important and why it should be done before you look at homes. A great real estate agent should give many of the same above reasons why getting a pre-approval will be beneficial in the long run! Don’t make the mistake that many buyers do, which is not getting their pre-approval in order before looking at homes.
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