Everywhere you hear “You need to get pre-qualified for a mortgage before you buy a house.” Then you talk to someone else and they say “No! You need to get pre-approved for a mortgage.”
Which is it? Well, it’s both really but for very different purposes.
To get pre-qualified requires a quick look at your finances, without pulling your credit score.
To do this, you need to bring a few things into a local mortgage professional of your choosing. Bring your paystub, W-2 or tax returns, and have a good idea of how much you have in your asset accounts (checking and savings accounts, any investments, and your 401k).
The lender will look at your gross income less your monthly long-term expenses (items like car loans, student loans, credit cards, etc.) and multiply this by an “ideal” debt-to-income ratio of normally around 36%.
This will give you a final number that is a basic estimate of what you can afford. At this time your credit score, employment history and other items like how much of a down payment you can afford won’t be seriously reviewed.
If you would like a more in-depth look at these calculations this post outlines it further.
It’s beneficial to look at what you can pre-qualify for when you’re first starting to look for a home because it gives you a great idea of how to prepare yourself for your future home purchase.
Pros of getting pre-qualified
- It will help you get an estimate of how much you can get a loan for.
- If the mortgage payment is higher than your rent, you can start planning to see if this is a feasible monthly payment for your financial situation (remember, a 36% debt-to-income ratio doesn’t suit everyone).
- It will help you answer if you should be saving more for a down payment to lower your monthly payment or qualify for a larger home.
- You will get an idea if it will be helpful to pay off your other debt before buying a home, so your debt-to-income ratio is lower or to give you more room in your budget to confidently make your new mortgage payment.
Getting pre-approved is a much more in-depth process that starts with you completing a loan application and involves a thorough review of your income and asset documentation, employment history and credit score.
You will need to make an appointment with a lender or mortgage broker to thoroughly fill out your loan application, making sure your information is all correct. The more accurate your application the fewer issues will arise in the long run.
Here’s a quick list of what you will need to take with you:
- Your ID and Social Security card so the lender can pull your credit score
- Your income information (W-2’s, most recent paystub or two years tax returns if you’re self-employed, and potentially business tax returns and profit and loss statements as well)
- All your asset documentation (most recent statements for all of your bank accounts checking, savings, 401k, investment accounts, etc.)
- A list of your monthly long-term debts (compare this with your credit report before you go so you can correct the report ahead of time if needed)
The lender or mortgage broker will thoroughly review your loan application and then determine what your gross monthly income is. At this time they will pull your credit score and report to make sure there are not any red flags in your file, such as:
- Not having two years in the same line of work or gaps in employment
- Lower credit score or issues (any late payments, a bankruptcy or foreclosure) on your credit report
- A higher debt to income ratio (over 36% is considered higher)
- Not enough in your asset accounts for a down payment and reserves (a few months of mortgage payment in your account in case of emergency)
- A large deposit in your account that is unaccounted for
If you are self-employed and you have had drastic change in income on your tax returns
If everything checks out, the lender or broker may put your file through an automated underwriting process and can give you a computer-generated loan approval based on the information you’ve provided. Otherwise, they will send your file off to an actual underwriter (a person who reviews your file for the bank to best determine if your credit file fulfills the banks’ requirements) to give an even more thorough review of your finances.
It’s important to note that a pre-approval is not a final guarantee of receiving actual loan approval, but it is one step closer to getting a more conclusive review of your finances. It’s also understood by most home sellers that a pre-approval means you are a more serious buyer, versus a buyer who only has a pre-qualification or neither of these.
So, to sum it up, getting a pre-qualification is a very important step in the home buying process for planning purposes and getting your finances organized to buy a house. Getting pre-approved is a much more involved process but is also closer to getting your loan approved.
About the Author: Kelly Leiby is an online home buying educator who wants to guide you through the sometimes difficult home buying process. Her passion is teaching you how to buy a house, invest smart and build your financial future at her site www.prohomebuying.com or follow her on Twitter at @ProHomeBuying.