There's no getting around it — buying a home is a stressful process. After all, you're making what is likely to be the largest purchase of your life and a lot needs to go right to make it happen.
As with most things in life, preparation is your friend when it comes to buying a home. If you want to get pre-approval or to pre-qualify for a home loan, use these tips to get that coveted stamp of approval.
1. Understand Pre-Qualification and Pre-Approval
People often use the terms "pre-approval" and "pre-qualification" interchangeably. In truth, they're far from the same thing when it comes to a mortgage.
A pre-qualification is an informal screening. You report your income, debt, credit score, and other criteria. The mortgage lender tells you whether you pre-qualify and may estimate your potential loan terms if that information is correct.
A pre-approval, on the other hand, is a far more firm and formal process.
The lender does everything they would normally do to approve someone for a mortgage. They review your income information, examine your credit report, and more.
At the end of the investigation, they either deny or commit to lending you a certain amount of money for a mortgage if you were to follow through. While it is conditional on your finances staying the same, a pre-approval is as close to a guaranteed mortgage as it gets.
Both a pre-qualification and pre-approval have their places. When you find lenders you like, try a pre-qualification to see if you're likely to be approved. If so, move forward with the pre-approval process.
2. Run Your Credit
Knowing your credit report is one of the most essential things you can do to protect your finances. It's also one of the easiest.
Get a free credit report for yourself every year from all three credit bureaus. You have a right to this free annual report by federal law.
You should receive a number for each credit bureau, known as your credit score. Most traditional mortgages require at least a 600 credit score. Many lenders have a bottom limit of 620 instead.
With 850 being the highest possible score, you want your score to be as high as possible. Your credit report will show you your score and show you the top negative factors that are lowering your score.
This gives you a clear to-do list for improving your credit score if necessary.
3. Pay Down Debt
One of the key factors a lender will consider in your pre-approval is your debt to income ratio or DTI. Your DTI is the percentage of your monthly income that goes toward the minimum payments for your debts.
For example, let's say you make $5,000 per month. Your car loan costs $250 per month. You have student loans with a minimum payment of $150 per month and credit card debt with a minimum payment of $100 per month.
All those minimums add up to $500 per month. You expect your new mortgage to cost $1000 per month, so your total debt payments per month will be $1500. That gives you a DTI of 30%.
The lower your DTI is, the better. When you pay down certain types of existing debt like credit card debt, it makes your minimum payments smaller. This improves your DTI.
What should be your goal for your DTI? Most lenders look for a DTI of 36% or lower. However, 50% is usually the highest DTI that will allow you to qualify for a mortgage.
Remember that the type of mortgage you pay off matters. For example, most auto loans keep the same minimum payment no matter how close you are to paying off the loan. With credit cards, your minimum payment is based on how much you currently owe.
This is why you should pay off credit card debt before car loans or other debts with fixed monthly payments. As an added bonus, lowering your credit card debt will boost your credit score.
4. Hold Off on Major Purchases
Speaking of credit cards: if you're preparing to buy a home, now is not the time to splurge on your credit cards.
Lenders don't want to see large recent balance increases on your credit cards. Not only does it hurt your credit score and your DTI, but it makes you look less stable with your finances.
This also applies to the time period between your pre-approval and closing on a home. Your financing can fall through at any point before closing time. Wait until you have the keys in hand before buying furniture for that new house.
5. Do Your Research
When you're seeking a mortgage pre-approval, the lender doesn't just get to choose you. You get to choose the lenders, too.
Do your research and choose a few lenders to apply to.
One factor to consider is your credit score. Some lenders offer great interest rates but they only approve buyers with high credit scores. Others are more specialized in lending to people with lower credit scores.
You also need to think about your down payment. Different types of mortgages have different minimum down payment amounts. You don't want to waste your time applying for a pre-approval on a mortgage that requires twice as much for a down payment as you have saved.
Don't be afraid to ask questions. Find out a lender's minimums and the options they offer before you apply. Read reviews as well to find out if their current customers are happy with their service.
6. Keep Your income Stable
Your income is a vital part of your pre-approval because lenders need to know that you have the means to pay them back. Your lender wants your income to be as stable and predictable as possible.
For that reason, if you're preparing for a mortgage pre-approval, now isn't the time to change jobs. Accepting a promotion from your current employer is fine, but don't change employers or careers right now.
As with your debt, this advice carries through until you close on a home. If you change jobs or quit your job before closing, it could delay the process or your mortgage could fall through altogether.
7. Choose Your Timing
Time may not heal all wounds, but it can heal a credit report if you play your cards right.
Most negative factors will stay on your credit report for seven years. It may feel like ages since you resolved a collections account five years ago, but it will come back to haunt you with a mortgage pre-approval.
If you have a negative mark on your credit report that isn't far from the seven-year limit, it's wise to wait until you've crossed that line. If you can't, the longer it's been since that negative factor appeared, the better.
8. Cram Your Schedule
Speaking of timing, did you know it's best to apply for pre-approval from lenders in as short of a time period as possible?
It's always wise to apply with multiple lenders to compare the interest rates and loan amounts they are willing to offer you. If you apply for all of them within a two-week period, they will affect your credit score as a single hard inquiry.
A hard inquiry is an application for new credit, like a credit card application or loan application. If you have more than two hard inquiries within a year, it starts to lower your credit score.
This happens whether those credit applications are approved or denied.
If you apply for pre-approval from three lenders within two weeks of each other, your credit report sees one hard inquiry. If you wait a month between each application, the report shows three hard inquiries.
9. Know Your Real Down Payment
One of the most common mistakes and misunderstandings with buying a home is about the closing costs.
Closing costs, which are usually about 3% of the home's sale price, are out-of-pocket. That means you need to have that money in your savings account ready to go.
Homeowners who don't understand this may think they have more of a down payment saved up than they do.
For example, let's say you want to buy a $100,000 home. This would incur about $3,000 in closing costs. If you have $15,000 saved up, $3,000 of that goes to closing costs, so you only have a down payment of $12,000, not $15,000.
10. Start Organizing Your Documents Now
It's never too early to start getting organized, and that holds true with a mortgage pre-approval.
To be pre-approved, you'll need to submit documents like tax returns, pay stubs, and bank statements. Create an organization plan now to keep track of these documents when they come in.
The last thing you want to do is spend hours digging through a pile of papers to find your last pay stub.
This is especially true if you're self-employed or if your income varies for other reasons. Most lenders require two years of income documentation in that case, so start gathering documentation now.
Getting Your Ducks in a Row to Pre-Qualify for a Home Loan
Taking steps to pre-qualify for a home loan or get pre-approved for a mortgage will be crucial for your home-buying process.
It may feel overwhelming, especially for first-time home-buyers. However, the tips above can help you get that pre-approval stamp with as smooth a process as possible.
Thanks for reading and happy home buying 🙂