You know how much you can afford, but what does the bank think? It may be willing to lend you an amount that could get you into trouble financially; on the other hand, it may not be willing to lend you as much as you would like.
The reason you need to know what the bank will let you borrow before you start shopping for a house is that real estate agents won't waste their time showing houses to buyers who might not be able to come through with the financing.
Also, you don't want to think you can afford a $350,000 house, start looking, and then find out that you can only get a loan for $250,000. The features that come with the $350,000 house won't exist in the $250,000 house and you'll be setting yourself up for disappointment. Finally, a seller isn't likely to accept an offer from a buyer who hasn't already secured financing. Why should they waste valuable days taking their home off the market while waiting to see if you can get a loan?
Getting pre-approved is pretty easy. It's just a matter of calling a few lenders and giving them about 20 minutes worth of personal and financial information, then following up with supporting documentation and waiting for a decision from an underwriter. To streamline the process, gather the following data before you call. (To learn more, read Pre-Qualified Vs. Pre-Approved - What's The Difference?)
Getting Pre-Approved for a Mortgage
In order to get pre-approved for a mortgage, you will need to provide information for everyone who will be a borrower on the loan (for example, both you and your spouse):
- Zip Code
This tells the bank where you plan to purchase (this isn't crucial, so don't worry if you're considering multiple zip codes - just pick one).
- Down Payment
This is the amount you're putting down (as a percentage). The minimum lenders require will depend on current market conditions and the type of loan. Federal Housing Administration (FHA) loans and Veterans Affairs (VA) loans traditionally have lower down payment requirements. (To learn more about FHA Loans, read Understanding FHA Home Loans.)
- Social Security Number
The bank will use your SSN to run a credit check during the application process - this can be done instantly while you're on the phone. The purpose of the credit check is to determine your monthly debt payments, which will affect how much additional debt the bank will let you take on for your mortgage, and to determine your credit score, which will determine what interest rate you're eligible for (or if you're eligible to borrow at all). The lender is required to tell you your credit score, so there's no need for you to pay for your own credit report to get this information. If there is more than one borrower, the lowest credit score is the only one the bank will count. (For more about your credit score, see Consumer Credit Report: What's On It.)
- Employment Information
You will need to tell potential lenders where you work, including contact information for your current employer. The lender needs detailed employment information on all borrowers to determine whether the mortgage will be paid reliably. Your should also know the number of years you've worked for your current employer, your job title or line of work and the number of years in your current line of work (if your job title or line of work isn't cut and dried, pick the one that will give you the longest track record in that field because lenders look favorably on a longer amount of time in the same line of work).
Know your base annual or monthly income before taxes if you work for someone else, after taxes if you're self-employed (no, it's not fair), anticipated for the current year and actual for the previous year. Also calculate your annual or monthly overtime hours. This has to be consistent for two years to count. If you made $3,000 in overtime this year and $1,500 in overtime last year, the lender will consider you to make only $1,500 in overtime, reliably, each year when considering how much home you can afford. The same reliability test applies for your annual bonus (so if you got a $2,000 bonus this year and a $0 bonus last year, as far as the bank is concerned you don't make a bonus). The same goes for any other sources of income (such as interest and dividends).
You should research and bring estimates for homeowners' insurance and tax rates to your lender when you are looking to get pre-approved. The lender can estimate these for you, but the lender's estimates often will be quite inaccurate. If you've done your research, you can supply the lender with your own numbers. (For information on shopping for homeowners insurance, see Beginners' Guide To Homeowners Insurance.)
- Net Worth
Add up how much money you have in all your accounts (one by one): retirement, savings, checking, brokerage, etc. You do not need to supply account numbers at this point.
Usually, at the end of this conversation, the loan officer's computer will spit out a purchase price that you can afford. This is commonly referred to as pre-qualification. The terms pre-qualification and pre-approval get swapped all the time, but for the purposes of this article, we'll use pre-qualified to mean that you've just completed the quickie application process over the phone, and pre-approval to mean that an underwriter has reviewed supporting documentation of your financial situation (such as previous years' tax returns and two months of bank statements) and generated a final number for the maximum amount the bank will lend you. You want to obtain pre-approval, not pre-qualification, before you start shopping for a house.
At the pre-qualification stage, lenders will usually give you a preliminary good faith estimate that will list the loan amount you might qualify for, interest rate you might qualify for and what your closing costs might be. These numbers are all estimates and, despite the name of the form, the lender can give you any numbers they want to try to get your business, so take these numbers with a healthy dose of skepticism. What you're really trying to do here is judge different loan officers. The most important thing in choosing a lender is not choosing the one that gives you the cheapest good faith estimate, but choosing the one that seems the most trustworthy, knowledgeable and reliable and tries to give you the most realistic good faith estimate possible at this point. If you have a friend or relative who can recommend a lender, that's a great place to start.
The bank may say you qualify for more or less than you think you should. If the bank says you qualify for less than you think you should (or less than you know you need to buy the type and location of home you want), don't take this as a final answer. There are things you can do in a relatively short time to improve your attractiveness to lenders such as repairing your credit, decreasing your debt, increasing your savings and getting a higher-paying job in the same line of work. (To learn more, read Make Yourself A More Attractive Mortgage Candidate.)
If the bank says you qualify for more than you think you should, ask how the estimate was calculated. That's a perfectly reasonable question that any competent loan officer should be able to answer easily. You shouldn't take the lender up on an offer that doesn't match with your estimates, but the good news is that you shouldn't have any trouble getting the loan amount you actually can afford.
Once you've pre-qualified with a few lenders and decided which you might prefer to work with, you'll want to pass the underwriting test so you have a genuine pre-approval that will allow you to make an offer on a home as soon as you find one you want. All lenders will want similar paperwork from you for this process, so get it together before you apply - it may take longer to gather than you think. Here's a list of commonly requested paperwork:
- Last two months of statements for all asset accounts (savings, retirement, brokerage, and checking if you keep a lot of money there)
- Last two years' W-2 Forms
- Last two years' tax returns
- Most recent month's pay stubs (your last two pay stubs if you get paid every two weeks and your last pay stub if you get paid monthly)
- If you're self-employed, a year-to-date profit and loss statement
- 1099s for the last two years
- Copy of driver's license
- Copy of Social Security card
Expect to wait at least a week to get your real pre-approval. It may take longer depending on the underwriter's work ethic, work load and whether additional documentation is required from you. The entire loan pre-approval process, from gathering your information and paperwork to calling several lenders and passing underwriting will probably take you a bare minimum of two weeks unless you have nothing else to do. When you're trying to juggle applying for a loan with work and your other day-to-day responsibilities, it's easy to spend even a month or more in this stage because you can't find time to work on your loan every day.
Once you have a written pre-approval letter in hand, you're almost ready for the fun part - home shopping. But first, you must find an agent.Buying A Home: Find An Agent
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