You should start by getting prequalified or preapproved for a home loan before you start your search for a home. Prequalifying or preapproval helps you determine the amount of home you can comfortably afford and informs sellers that you are a credible buyer. This places you in a favorable negotiating stance when you finally locate the right home to purchase. But how does the lender decide on what amount they are willing to lend to you? Below is a list of what is involved in a lending pre-qualification and pre-approval and the amount of money one qualifies to get from a mortgage loan.
What is a Mortgage Prequalification and Preapproval
Prequalification and preapproval are related but distinct processes because they require different types of documentation and have varying levels of certainty about the loan amount.
Prequalification Pre-approval is an initial decision the lender makes regarding the amount he or she would be willing to lend based on the information you give. Sometimes you will disclose income, debt, down payment, and credit score limits. This information is taken to provide you with an approximate maximum loan size and home price range that you may qualify for. A prequalification is fast and provides an estimated number to use while applying for the loan but should not be confused with a preapproval.
Preapproval The preapproval process is a bit more complex but it gives a much stronger approval at the beginning. To get preapproved, you fill out a full loan application that requires you to supply a range of detailed information about your financial status: pay stubs, tax returns, bank statements, investment account details, and much more. The lender then ensures all this is accurate and conducts a credit, income, asset, debt and down payment verification. According to the laid down federal guidelines that lenders have to adhere to, you get a preapproval letter that indicates the maximum amount of loan, the interest rate and terms that you meet. A preapproval letter demonstrates to sellers that you are a highly-credentialed buyer with the ability and willingness to proceed with the purchase.
Aspects That Define the Amount of Your Approved Loan During the prequalification/preapproval process, there are several factors that are taken into consideration when determining how much can be lent to you. These factors include
Employment Income – Your monthly total salary, overtime pay, bonuses, any other remunerations you receive are all summed up and compared to the qualification income. Ideally, the lenders would like to see that this steady additional income will be sustained for the next three years at the very least. Self-employment income utilizes your last two years of tax returns.
Standard – All the monthly debt payments such as credit card balances, student loans, car loans, existing mortgages etc are determined. These reduces on the money that one is able to set aside to cater for a new mortgage payment.
Down payment – A down payment decreases the amount of the qualified loan because the borrowers receive less of the total home value from the lenders. Conventional loans are generally accepted to need no less than a down.
Credit history – Your credit report and ratings determine your mortgage rates and eligibility. In general, to qualify for a conventional loan, you need a score of at least . The higher the scores the better the chances of securing the lowest possible rates.
With these pieces of your financial picture, mortgage lenders use two calculations to arrive at the maximum loan to income ratio that is your maximum affordable loan leading to a home purchase price.
DTI Ratio Debt to income or DTI ratio is the total of monthly obligations and gross monthly income. Almost all standard mortgages expect your total DTI to be below . Well if you earn $ in terms of monthly income, and pay $ in terms of debt payments then your DTI is. This means you should qualify for a new monthly mortgage payment up to around $.
Loan to Value Ratio LTV Ratio Your down payment and total home price go to arrive at your LTV ratio, which lenders prefer to below for a conventional loan with PMI. For instance, home price of $, down payment of $, the mortgage amount of $, gives the LTV of . Understand that for every added percentage to the down payment, you may be eligible for more funds in the loan.
Prequalification Example Combining these guidelines, it is possible to look at the following example Gross monthly income Credit scores above No other debts , down payment This borrower should be able to get pre-approved for approximately a , mortgage loan. Which means they may be able to buy a home up to around , depending on estimated taxes, insurance and HOA fees. This prequalification amount can then be adjusted during official preapproval once more stringent documents such as bank statements, tax returns and other documents that show the credit worthiness of the purchaser are provided.
You see, prequalification and preapproval are not definitive financing but they do initiate the process to assist you in developing an accurate price range or budget when searching for a home. It also saves time because sellers only get to show you houses that you can afford when you prove that you have the financial muscle to buy them. Thus, it is necessary to contact lenders to find out where you may be positioned with that amount offered through preapproval.
