Real Estate Guide

Your Mortgage - Questions and Answers
'Loan Pre-qualifying and Pre-approval'

• What is the first step when looking for a home loan?
• What can I afford?
• Does pre-qualifying help determine how much house I can afford?
• How do you qualify as a first-time buyer?
• What is the difference between being pre-qualified and pre-approved?

What is the first step when looking for a home loan?

Most experts recommend that you should get pre-qualified for a loan first. By being pre-qualified, you will know exactly how much house you can afford. Almost all mortgage lenders now pre-qualify and pre-approve customers, and many of them can even do it on the Internet.

You also can do your own affordability calculations; most recent consumer books on home buying include steps to doing so, as do various real estate Internet sites.

See >> Home Buyer's Top Ten Tool #4 -  Home Affordability Calculator.

What can I afford?

Know what you can afford is the first rule of home buying, and that depends on how much income and how much debt you have. In mortgage parlance this is known as your debt to income ratio. In general, lenders don't want borrowers to spend more than 28 percent of their gross income per month on a mortgage payment or more than 36 percent on debts. However, under pressure from Congress these ratios were relaxed in the early 2000's, a fact that contributed greatly to the mortgage meltdown of 2006. 

It pays to check with several lenders before you start searching for a home. Most will be happy to roughly calculate what you can afford and pre-qualify you for a loan. The price you can afford to pay for a home will depend on six factors:

1. Your gross income
2. The amount of cash you have available for the down payment, closing costs, and cash reserves required by the lender
3. Your outstanding debts
4. Your credit history which gives you your FICO credit score
5. The type of mortgage you select
6. Current interest rates

Another number lenders use to evaluate how much you can afford is the housing expense-to-income ratio. It is determined by calculating your projected monthly housing expense, which consists of the principal and interest payment on your new home loan, property taxes and hazard insurance (or PITI as it is known).

If you have to pay monthly homeowners association dues and/or private mortgage insurance, this also will be added to your PITI. This ratio should fall between 28 to 33 percent, although some lenders will go higher under certain circumstances. Your total debt-to-income ratio should be in the 34 to 38 percent range.

See >> Home Buyer's Top Ten Tool #4 -  Home Affordability Calculator.

Does Pre-qualifying Help Determine How Much House I Can Afford?

Before you start your house hunting in earnest, the real estate professional with whom you are working likely want you to be pre-qualified by respected lender to determine the price range of homes in which to begin searching.

"Don't be shy or withhold information about your income or credit status. Your real estate professional isn't trying to pry. Rather, he or she must know all details related to your ability to obtain a mortgage," Al Leonard, ABR^®, CEO of RE/MAX Valley Real Estate, Boardman, Ohio says.

By candidly discussing your financial situation, you'll give the agent the information necessary to show you homes you can afford, Leonard notes.

"If you don't open up, you are placing the real estate professional in the role of a tour guide, not someone who can help you find a home within your budget. You'll wind up wasting your time and that of the seller," he says.

Once you have signed a contract to purchase a home, you must choose a lending institution or mortgage company from which to obtain your home loan. Your loan application will request financial data including your place of employment, assets, and liabilities (including recurring debts such as credit card bills and car payments).

Here are two important tips on loan qualification from RE/MAX Valley Real Estate:

1. Do not borrow the down payment without disclosing the loan, submit fake letters-of-credit or gift letters, or make secret financial arrangements.
2. Accurately list your income and assets, all debts and the approximate amounts you owe.

You'll most likely be charged a credit report fee by the lender, which will cover the cost of having your credit history examined. Credit reporting agencies compile credit reports on consumers, including bill payment history, as well as whether you have been sued or filed for bankruptcy among other information.

Federal credit reporting laws do not give you the right to inspect the actual credit report at the reporting agency or to receive an exact duplicate of the report. But, you are entitled to a summary containing the sources of the report's information.

If your ability to obtain a mortgage is adversely affected by the credit report, you have the right to challenge its accuracy and seek corrections.

"The credit report is part of the information the lender uses to determine if you qualify for a loan. It is not a mechanism to prevent you from buying. Remember, lenders want to make loans, not turn them down," Leonard says.

Al Leonard is one of more than 40,000 members of the Real Estate BUYERS AGENT Council (REBAC) of the NATIONAL ASSOCIATION OF REALTORS^® , who have attained the ABR^®, Accredited Buyer Representative, designation. As the world's largest association of real estate professionals focusing specifically on representing the real estate buyer, REBAC is "The Voice for Buyer Representation," with more than 44,000 active real estate professional members of the organization throughout the world.

See >>

 Home Buyer's Top Ten Tool #4 -  Home Affordability Calculator.

Experts agree that spending more than 2.5 times your gross annual income on a home isn't wise, and most lenders will require your mortgage payment to be less than 28% of your gross monthly income. Our calculator will give you a very good idea of how much you can afford to spend on a home, based on your current income and current debt.

How do you qualify as a first-time buyer?

In general, lenders define a first-time home buyer as someone who has not owned any real estate -- whether a personal residence, vacation home or investment property -- during the past three years. Lenders verify an applicant's status by examining their income tax returns, checking to see that the individual did not take any deductions for mortgage interest or property taxes.

In Ohio, the Ohio Housing Finance Agency (OHFA) offers affordable housing opportunities for Ohioans and has programs to serve first-time homebuyers, renters, senior citizens and others with special needs who otherwise might not be able to afford quality housing.

See Also:

• Becoming a Home Owner For The First Time
• Here are 12 tips to help you become your own landlord.
• Real Estate Guide: Buying Your Home - $8,000 Tax Credit Available for Qualified First-time Home Buyers.

What is the difference between being pre-qualified and pre-approved?

When a lender says a buyer is "pre-qualified" it simply means that based on information the buyer has given them, the buyer should be able to get a loan. However, except for a cursory credit check, at this point, nothing the buyer has said has been verified.

However, when a buyer is "pre-approved", it means that the lender has already run a full credit report, verified employment, and determined the existence and source of the down payment funds. The lender will have completed everything needed close the transaction with the probable exception of a certified appraisal and a title examination to show the existence of any prior liens on the property.

Considering the above, there are three great benefits that go to pre-approved buyer:

1. You'll enjoy the peace of mind that after you negotiate the deal, there will be no surprises. You will know exactly how much house you can afford, and so will the seller.
2. Although there no doubt will (or should) be a financing contingency in your offer to purchase which would return your earnest money in the event you can't get the loan, sellers can be slow (and even refuse - contrary to the contract) to do so. Being pre-approved by your lender before making an offer avoids any hassle with earnest money.
3. Sellers will look more favorably on pre-approved buyer than a pre-qualified one and will often accept a lower price simply because they know the transaction is more likely to close. This is especially true in the event of multiple offers.