Buying a home can be a daunting task. For most of us, a home purchase represents the largest financial transaction we’ll ever undertake. And a house is not just a piece of areal estate – it is home, where we will live our daily lives and make special memories.
Since most of us won’t pay cash for our homes, obtaining a mortgage loan is a necessary part of the home-buying process. The mortgage experience doesn’t have to be stressful and overwhelming, however, if you follow some tips I’ll share with you in this and future articles, it will be a lot easier.
This month, I’ll cover pre-approval, the process by which prospective buyers find out if they qualify for a loan. It’s arguably the most important step on the road to homeownership, since it determines if the rest of the journey is even possible.
Two Levels of Pre-approval
There are effectively two levels of pre-approval. The first is a simple pre-approval letter – the most common demonstration of a buyer’s creditworthiness.
A loan officer reviews a completed loan application as well as the credit, asset, and income documentation provided by the buyer. If everything checks out, the loan officer will sign a pre-approval letter, which outlines the price range the buyer can afford and what type of loan he/she may qualify to receive.
For the second level of pre-approval, an underwriter reviews the work done by the loan officer and issues a Banker Loan Approval document. Underwriters are trained operations professionals within the lending institution who are experts in risk management and program guidelines, so the Banker Loan Approval document carries more weight than a simple pre-approval letter. Because underwriters will also need to issue final loan approval, involving them in this early review of your application will smooth the path later on.
The first step in obtaining a pre-approval or Banker Loan Approval requires you to share a variety of financial information with your mortgage professional. This data will help determine if you qualify for a loan, and if so, for what amount. You don’t want to find your perfect house only to discover later that you can’t afford it!
The information you will need to submit may include recent paystubs or other proof of income, copies of your income tax returns, statements of financial assets (e.g., checking, savings, money market, and retirement accounts), documents related to previous bankruptcies or foreclosures, and information related to any other properties you own.
Your mortgage professional will also review your credit to make sure there are no unpleasant surprises lurking on your credit report. These could range from simple credit reporting errors to a bad debt left unpaid by someone for whom you co-signed a loan.
Mortgage Analysis: a Detailed Process
Your income is another piece of data that may not be as simple as it seems. Without a proper mortgage analysis, which includes a line-by-line review of your tax returns, you could run into trouble at the 11th hour – at the very moment when you thought you would be handed the keys to your new home. Many times in my career I have witnessed a real estate deal fall apart at the last minute because a bank underwriter discovered a problem too late in the process.
Avoid Disaster by Getting Pre-Approved
For example, several years ago when I was working in North Carolina, we had a young couple sitting at the closing table in the real estate attorney’s office, waiting for their lender (a big bank) to finish its due diligence. Much to the horror of the young couple, the bank underwriter discovered the income on their loan application had been calculated incorrectly by their loan officer. The error was so significant that this couple no longer qualified for the loan.
The deal collapsed, setting off a domino effect. The buyers lost $2,000 in earnest money, the sellers had to move back into their home until another buyer came along and could not close on their purchase of a new home, and on and on. I’m not sure these buyers had obtained either type of pre-approval; it seems very unlikely that they did. A more thorough review during the pre-approval stage would have prevented this situation from developing in the first place.
Save Time by Doing Things Right!
Securing proper pre-approval will also save you time during later phases of the home-buying process. If all of the due diligence to obtain a loan isn’t handled upfront during pre-approval, it will compete for your attention when you need your time the most – at the very end of the home buying process. This is why it is absolutely crucial that the loan pre-approval is done first, before signing a purchase contract.
Signing the purchase contract will set off a series of deadlines for inspections, appraisals, and a final check of your finances. In Florida, real estate contracts typically include a financial contingency clause with a deadline. After this date, if your loan is turned down for any reason, you may lose your earnest money and may be liable for breach of contract.
If you have undergone a thorough pre-approval, you will minimize the odds of this occurring. Would you rather be packing and moving in the days leading up to your closing, or frantically digging through boxes you’ve already packed to find documents you need in order to close your loan?
I can’t emphasize this point enough: obtain your pre-approval BEFORE entering into a purchase contract!
Make Your Offer Stand Out
Pre-approval also gives you an advantage in our current seller-dominated real estate market. With a low inventory of homes for sale, sellers can often choose among potential buyers. You can be sure that a seller deciding between two similar offers will prefer an offer accompanied by a pre-approval letter over an offer without one. And if each offer comes with a pre-approval letter, sellers would be wise to pick a pre-approval letter that has undergone a higher level of scrutiny—the “banker loan approval” described above. When buyers handle the pre-approval piece of the puzzle in a smart way, it shows sellers that buyers have done their homework and that they means business.
Pre-approvals can vary in strength, depending on the lender. A pre-approval from one of the big banks won’t carry as much weight as one from a local industry leader, such as a mortgage professional employed by a local firm which is respected and trusted by the local real estate community.
Big banks often get their mortgage clients from checking account customers or branch walk-in business, whereas local boutique lenders depend upon referrals from real estate agents who have come to trust them. Remember that big banks are big; loans can easily get lost.
Having previously worked for one of the biggest banks in the U.S., I’ve seen with my own eyes how buyers’ loans sit untouched for weeks on the desks of over-worked loan processors. (rate customers showed up so often at our offices there that our doors were kept locked from the inside!.
Choose your mortgage professional wisely!
In conclusion, you can avoid much of the stress associated with obtaining a mortgage if you follow these tips. Ask your real estate agent if they can recommend a mortgage professional at a reliable local lender, one who will perform a thorough pre-approval early in your home-buying process.
With a pre-approval letter—or even better, a letter with a bona-fide banker loan approval document—in hand, you’ll be in the best possible position to find and purchase your dream home.