What is a Mortgage Pre-Approval, Anyway?
Technically, Pre-Approved is any time before approval right..?
So you’re on Zillow.com, casually browsing for homes in your area to see if there’s anything that you’d like to buy. There are a few nice houses, some that have potential, and a few that you wouldn’t live in if your life depended on it.
And then you see it: THE PERFECT HOME!
It’s the right location, perfect size for you and your family (even your dog!), and the price…well, is it a good price?
How can you tell if the price is right? What about the monthly payment? Zillow has an estimate, but is that right? Is that monthly payment even CLOSE? And if it is, can you actually afford it?
Those questions answered and so much more in this Introduction to the Mortgage Pre-Approval process!
Analyzing Household Income
If you’re a W2 employee (meaning you have a job with a regular paycheck) this will mean looking at the last 2 years of income, and your most recent paystubs. We will use your “gross monthly income” which basically just means before-tax income to determine the baseline of how we will compare your new monthly housing expenses.
if you’re Self-Employed (own more than 25% of your place of work) we will use your 2-year income history, however, we will use your personal and business tax returns rather than W2’s and paystubs. If you’re worried about qualifying with your tax returns, there are quite a few other options to qualify as a self-employed individual. For example, if you’ve been in business more than 5 years we can use 1 year of taxes, or even use bank statements to show your income rather than your taxes.
If you’re on a fixed income from retirement accounts, pension, long-term disability, or Social Security for a few examples it is just a matter of reviewing those account statements and applying the guidelines for the program to see what can be used. For example, retirement accounts need to have sufficient balance to continue the income for a period, and Social Security that is untaxed can actually be increased above what you actually earn.
Analyzing Assets for the Down Payment or Reserves
Probably the most straight forward step in the process, we will review your 2 most recent month’s bank statements, retirement accounts, gift funds from an employer or relative to calculate your assets and show that you’ll be able to make the payments you’ll need to close the transaction.
We even have a few down payment assistance options which we can consider in addition to your assets to determine the affordability of your new home. However, you will still need to show you have additional assets in reserve to make your first mortgage payments and for potential closing costs that will need to be paid.
Analyzing Your Credit and Determining Your DTI
Your credit score (the actual number) is a starting point, but we also need to look at the debt that is being reported on credit from car loans and student loans to credit cards and personal loans. By combining the minimum monthly payments from your credit report with the housing expense for the new mortgage, we can determine the Debt-to-Income (DTI) ratio when we compare that number with your gross monthly income from step 1. The housing expense is sometimes called “PITI” which stands for
- property Taxes
- homeowners Insurance
It also includes Mortgage Insurance and Home Owner’s Association (HOA) monthly dues (on Condos or PUD properties).
Confused? Don’t worry, we’ll take care of the math for you.
Different programs have different requirements for credit score and DTI, but we can go as low as the 500’s for credit and over 50% on DTI ratio.
Is that it?
How to go from Pre-Approval to Approval?
Go Find A Home!
The reason it is called a Pre-Approval is because a true Underwriting Approval requires review of the details of the property, including Title information, an Appraisal of the value of the property, an insurance policy etc.
So the last step is to go find a home!
To do that, we will discuss the price range of houses where you will be most comfortable with the down payment and the monthly payment. The we will work with your Real Estate Agent to discuss these details and prepare a Pre-Approval Letter which they can submit alongside your offers. When you do write an offer, we’ll call the Listing Agent to discuss the Pre-Approval and introduce ourselves.
Once your offer is accepted, we’ll take care of the rest so they can get started
Do you need to run my credit?
Remember when I asked if all Pre-Approvals are the same? Well, the answer is no, and the 2 places that Pre-Approvals typically fall short are:
- Not pulling credit
- Not knowing how to properly calculate income
If we don’t pull your credit, we don’t know what you can actually afford. Think you know what is on your credit report? Well, I can’t count how many times my clients have said “I thought that was gone after I paid it off!” or “that’s not what Credit Karma says!”
If you’re more than a few months from starting to shop for a home then we can probably hold off on credit for a bit, but just know that if you get a Pre-Approval from a Lender who hasn’t pulled your credit, that’s a major Red Flag that they are skipping steps elsewhere and your Pre-Approval isn’t worth the paper it’s printed on.
And again: where are they most likely to skip steps? Well, with the hard part, and that’s properly calculating your income. I have saved multiple transactions for clients who started out with a Lender who got them a “Pre-Approval” only to find out that they don’t qualify. Unfortunately, sometimes I couldn’t save the transaction and it has meant that the client didn’t get the house because the initial Lender didn’t take the time to do their job properly.
So, simply, Yes: I do need to pull your credit to issue a Pre-Approval Letter. It’s not the first thing I’ll do (it actually costs me a little money each time) and it’s not needed to get some preliminary numbers about what you can afford and what your payment will be on your new mortgage.
One final note on credit pulling: it doesn’t do me any good to pull your credit but it really is important for you to know what’s actually on your credit! And don’t worry about your score: unless you’ve had several credit pulls for another purpose (car loans, credit cards, etc.) it’s not going to do anything negative to your credit score. It used to hurt your score, but the modern credit models know that responsible people need to look at their credit so that’s largely a thing of the past.
Until next time!
I founded California’s Best Lenders to bring the best of Wholesale Mortgage Lending to as many people as possible. In nearly a decade of helping people of all backgrounds and walks of life achieve their dream of home ownership, I love sharing my expertise and experience.