Getting Approved for a Mortgage
Pre-qualifIcation – Getting Pre-Qualified is really just having a conversation with a lender where you discuss debts, income, and assets. Based on this conversation they will write a letter saying you are ‘pre-qualified’ for a mortgage of X number of dollars.
Pre-approval – Being Pre-Approved is better. It means all of the above plus verification of income, debts, and assets. Essentially, the lender is verifying that, provided nothing in the financial picture really changes, you are qualified to make a purchase within the allotted budget.
Pre-underwritten – This takes the process one step further by running income, debt, and asset verifications through the underwriters in the home office. Going through the pre-underwriting process is especially important when job changes have occurred recently, commissions or bonuses are a large percentage of your income, or there are other issues which might give an underwriter pause about your job history or income.
Types of Mortgages
For simplicity’s sake, the three basics types of mortgages are:
Fixed Rate Mortgage – In a Fixed Rate Mortgage, the interest rate does not change over the life of the mortgage. If you secured a fixed rate mortgage for 6%, the interest rate on your first payment is the same as on the last one. When rates are low, more buyers select a fixed option to lock in the rate over the life of the loan.
Adjustable Rate Mortgage (ARM) – In an ARM, the rate is subject to change at specified intervals. Typically, the language in the mortgage document will also contain caps which restrict rate adjustments by a specified amount in any given adjustment period. Typically, ARMs are either 1 year (meaning the rate adjusts yearly), 3, or 5 years.
The Hybrids – In addition, you will see hybrid products, which combine elements of both the fixed and ARM mortgages. Hybrids often offer a fixed rate for a period of time (say 5-7 years) and then either turn into a 1-year ARM or a balloon payment (i.e. full payoff). Market conditions and mortgage company speculation will often drive creation of hybrid loan products, which come into the market and leave with regularity.
Commonly referred to as ‘closing costs,’ the additional fees that accompany the home purchase often catch buyers by surprise. In most scenarios, closing costs will run anywhere from about 2% of the sales price to 5% of the sale price with 3% as the generally accepted norm. When a mortgage is used to purchase, the closing costs are far higher than when cash is used, as most of the closing costs are associated with obtaining a mortgage.
Lender Fees – A home loan is a big undertaking and comes with unfamiliar fees. Know that all of the fees you see on the closing statement should have been disclosed in detail by your lender at the time you made the official loan application, if not before.
Title Insurance – Title Insurance is an insurance policy you buy to protect your property rights and is a large contributor to the closing cost total. This insures that when you take title to the property, no one else can lay either an ownership or monetary claim against the property.
Potential Closing Costs:
- Homeowner’s (or Hazard) Insurance
- Recording Fees
- Tax Service Fee
- Floodplain Certification
- Courier Fees
- Escrows for Taxes and Insurance
For the most part, mortgage companies like to see 20% of the purchase price come from the purchaser in the form of actual cash, but don’t stop reading here if you don’t have 20%. It gets better!
The bank’s thinking is this: If you have $50,000 of your own cash in on a $250,000 home, then you will do what you need to do to make that payment every month. Likewise, if you fail to make your payments and they have to foreclose, they should be able to sell the $250,000 home for enough to cover their $200,000 debt.
That said, it does not take 20% to buy a home. You can do it for as low as 3.5% (or 0% if you are a Veteran). Many loan programs exist that allow buyers to purchase housing when they do not have 20% of the price for a down payment. The biggest difference is the effective interest rate you will get… the lower the down payment, the higher the effective rate.
Your Qualification Amount
In its simplest form, a lender will let you spend roughy 28% of your gross monthly income on housing, provided your total monthly obligations do not exceed anywhere from 36% to 50% of your gross monthly income, depending on the loan type. The first figure is called the ‘Front End Ratio’ and the second is called the ‘Back End Ratio.’
This 28% figure can go down if the other debts exceed 36%. Now, understand that different loan products may have slightly different ratios and other mitigating factors may exist. For example, recent graduates from medical school come out with high levels of debt and little cash, but with huge earning potentials… there are loans for Doctors where everything discussed above is thrown out the window. Likewise, debts near expiration may not count against the Back End Ratio.
The bottom line is that a good lender is a valuable team member. They understand the thousands of pages of underwriting guidelines and will know how to paint your financial picture correctly so that you receive the best rate.
The Online Lender
In this “Big Brother” age we live in, the minute your search patterns suggest you are thinking about buying, you become targeted by a slew of internet based lenders who all promise they can secure you the best rates.
- The online lender does NOT have better rates.
Online lenders like Rocket Mortgage or USAA promise the best rates, but they are all selling the same mortgage products backed by FHA, Fannie Mae, and Freddie Mac, who are the ones setting the base pricing.
The difference you see in rates comes from the difference in terms that are being quoted. There are 10-15 different factors that can impact a 30 year fixed rate mortgage rate quote including your credit score, down payment, income, employment history, geographic region, risk profile, or lock period. In other words, they are playing a classic bait and switch game where they are quoting the absolute lowest rate they can, but that typically doesn’t work for anyone’s actual situation.
- On top of that, many online lenders simply take your application and sell it.
LendingTree, E Loan, and Zillow do not originate loans, they simply try to sell you as a lead to other lenders.
Online lenders cannot offer you a rate without an actual loan application, underwriting approval, and ratified contract with a settlement date. So until a borrower has made a full application, supplied bank statements and other documentation, and has an actual settlement date, no lender can guarantee a rate!
- Online lenders miss closing dates with regularity.
Missing a closing date is bad. It sets in motion a series of very negative and costly events like storing your belongings, rate extensions, or last minute hotel stays.
When it’s crunch time, you don’t want to have to call an 800 number in a different time zone to find out why the loan package did not arrive.
- Online lenders use the cheapest service providers.
Who do you want doing your appraisal? The appraiser with 20 years experience in your neighborhood or the brand new appraiser from out of town who was willing to work for half price? Do you want to be able to select your own attorney or be told which one to use?
The online lenders use a bidding process to secure their service partners and using the lowest bidder for such an important transaction is not a winning strategy.
- Realtors® aren’t too fond of online Lenders…
Imagine you are one of three bids on the perfect home. You have been looking for months, have lost two other competitive bids, and are running out of time before you have to be out of your apartment. Do you really want to lose out because the Listing Agent told the seller to take the deal with the local lender? It happens all of the time.
Shop locally for your loan
At the end of the day, there is no reason to use the online lender. Speak with several experienced local lenders with reputations for not only service, but for on-time delivery. The local lender’s reputation is at risk for every loan they provide, so they have an incentive to perform well and get you what you need, at the precise hour when you need it.