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Getting preapproved to buy a home.

Getting preapproved to buy a home.

When one sets out to buy a home, they usually do a little bit of research. Because it is so important to a successful process, they are immediately are bombarded by Realtors telling them to get preapproved for a home loan. As I have read quite a few other real estate agents blogs and ad copy, I have noticed we are real good about telling you that you need to do it, some are even good about telling you the reasons why you need to do it, but very few of us talk about the process. As a result, more than a few of our potential clients view it as another one of the scary things banks put us through in life and avoid it… opting for a life of renting instead of the equivalent of a bankers root canal.

That’s where your hero Robb from the Blue Ribbon Team at Your Realty Link comes in. Today I am not just going to tell you why your Realtor wants you to get preapproved, I am going to go over the process so that you know what to expect, and what your lender is looking for in that process.

Why should I get a preapproval for a home loan before looking at houses?

There are a bunch of reasons, but two stand out. They are to make sure you are shopping in the correct price range, and to keep from wasting either of our time.

House shopping in the right price range. Why is this important? There is nothing wrong with a little window shopping, right? Incorrect. When looking for houses, window shopping will keep a person from buying a house that is very suitable to their needs and income. The reason for this isn’t that hard to understand. Like with all things, as you add more amenities to a home the price goes up. Unlike most other things we purchase, when the price goes up on a home, it can quickly become unaffordable to the buyer. Then the buyer has this mental block about this particular amenity that is not available in their price range. Once that mental block is there, it can be very hard to remove. If we don’t find a way to resolve that, they end up renting an apartment or house that still doesn’t have the amenity AND they never get to call their own. No one wants that… well except the land lord.

So before we start looking we want to make sure that we set appropriate expectations for what is available in the current housing market. The easiest way to do that is to get a preapproval before we look, so that we begin our search in the right price range.

Not wasting your time or mine. Buying a home is a big process. Sometimes it takes months just to find the right home. Usually we are ready to move to a new place the day we start looking… buying a house is exciting like that. So putting yourself in that situation, with that sense of urgency; would you spend months trying to find the perfect house and then apply for the loan, only to find out that there was some random black mark (and not even a valid one) on your credit report that kept you from buying a home? I do not think you would want that. I know I don’t. Lets be as straight here as I always am. I don’t make money unless (and until) you buy a home. Spending months on a deal that doesn’t close does not fit my business model or my household budget.

The good part of this is that it is easy to avoid. We help the buyer get preapproved for a home loan. If there are things which are making that difficult, I work with lenders who will help coach you into fixing your credit so that you can buy the home of your dreams. The surprising part to most people is that it is actually a very simple and easy process, once you know what to do.

What do I have to do to get preapproved to buy a home?

The short and sweet answer is to talk to your local mortgage lender, but I have a much more useful one coming. The thing is with all the regulations around lending these days I need to make a quick statement. That statement is that I am not a licensed mortgage lender. The following statements are intended for educational purposes only and are based on my observations of the mortgage industry as a whole and do not reflect the practice of any particular company.

Now that is out of the way, when you speak to a mortgage lender they are going to ask you for several things. All of them will be weighed when determining if and how much they will allow you to borrow a home. They will also be used in determining how much you pay in interest and fees when borrowing that money. The information they need is your identification, work documentation, credit history, and assets.

For identification a state issued ID or passport will suffice. They will also require your social security number. This information is to verify that you are who you say you are (which protects you from identity theft as much as it protects the bank) and as a means of accessing your credit history.

Your work documentation is a little more in depth. Typically you will be expected to provide 30 days of pay stubs and 2 years worth of tax data (w-2’s, 1099’s, and tax returns). This verifies your employment for the lender and gives them your income.

Your credit history will be pulled by the lender. To do this they need the identification your provided and your permission. I want to mention here that people often freak out about this as “hard pulls” on your credit can hurt your credit score. While this is true, if you are pulling your credit a couple of times a year it has a negligible effect. It only hurts you if you are making loan application after loan application. When they pull your credit history they will be looking at two things. First is your FICO score. The second is they will compare your total reflected debt to your income to determine your debt to income ratio. We will discuss how those are used in the next section.

The fourth thing the lender will review is your total assets. The primary reason for this is to determine if you can make a down payment and how much of one you can make. It is typical for lenders to require 3 months worth of statements from all checking, savings, and investment accounts.

Once the lender has all of this information, they will use it to determine how much money to lend you and how much it will cost.

How does the lender use that information to preapprove me for a home loan?

Once the lender has all of that data, they are going to compile it and look at 3 main factors; your FICO score, your debt to income ratio, and down payment available.

Your FICO score. If you haven’t heard it called that, your FICO score is that 3 digit number that people refer to as their credit score. In the home loan process it is primarily used to determine what loan programs you qualify for. For instance, most conventional loans require a score of 680 or higher. VA Home loans don’t have an official score, but the benchmark most lenders use is 640 (some can do it at 620 and I have been told that some will go lower but I have yet to actually see it). FHA and some other lower income loan programs can be financed down into the high 500’s.

That said, these numbers are minimums. The higher your FICO score the better loan programs are available to you, and by better I mean they have less fees, lower interests and much more generous rules than programs available to lower scores. This is because the FICO score is how a lender determines the risk they are taking, and the less risk they take, the less money they need to make in order to mitigate the losses suffered by the loans that go into foreclosure.

Income and debt to income ratio. This more than anything will determine how much of a loan you qualify for. While this can sound like a complicated thing, it is really pretty simple when you break it down to its separate parts.

The first is just income. The loan officer will take your NET income, and multiply it by 4. Our example today has a NET income of $50,000 per year, so before figuring their debt to income ratio, they could potentially qualify for up to a $200,000 house.

The debt to income portion narrows that a bit, and is a little more complicated

Basically the loan officer is going to use your work documentation to determine your monthly income. Then they are going to use your credit report to determine your monthly debt service payments. When they combine this information they can determine your debt to income ratio. Depending on credit score and the lenders loan programs you need for your total (including housing) debt to income ratio to be under 43%, with a target much more like 38% to prevent the need for an excellent credit score or high down payment.

For instance, lets assume that your NET (that is after tax and withholding) income is $50,000 per year. This gives you a monthly income of $4166.67. If your monthly debt service (car payments, credit cards, medical bills, etc.) is $1041.67, then you have a debt to income ratio (minus housing) of 25%. The lender wants your total debt to income (including housing) to be under 43%. This means that you would qualify for a home with a payment of less than $750 per month.

Because of this buyers debt load, they would only be able to buy a home for $113,000 (after down payment- this estimate assumes 4% interest, 30 year term, 1% property taxes, .5% pmi, homeowners insurance of $1000 per annum, and NO HOA fees. As will the further examples in this article).

To show how important reducing your debt load is to buying a home, if that same buyer reduced his debt to where his monthly payments were around $500, then they could afford a house payment of $1289 a month and be shopping for homes that would give them a home loan of $200,000 after down payment. I don’t think I need to tell you how much of a difference there is between a $113,000 house and a $200,000 house. It is night and day.

So now you at least have an idea of how your income and debt to income ratios influence your credit worthiness, now lets look at the last big piece of the puzzle, your available down payment.

Your available down payment will determine what loan programs are available to you and how much money you can borrow. When I set out to write this article, I was going to lay out all the rules for where your down payment can come from… and then I realized that this is already a wall of text, and it would take another one just like it to detail the rules just for an FHA loan. So I am going to give the fast and dirty, and if you are nice to me I will write another article that details down payments more deeply.

For now here is the thing. The more you put down, the less you finance; so you save money. Your down payment should primarily come from your savings. There are limits to how much and who can give you money for a down payment. The bank will want all down payment funds to be documented. The longer they are in your accounts the less that is an issue.

Also, different loan programs can give you different required down payments. I have one lender that with the right credit score can give you a 1% down payment on a conventional loan, and on the other end a basic conventional loan requires 20% down. There are a multitude of programs in between based on your specific circumstances.

Once I know your basic information, I will refer lenders who have suitable programs for you and they in turn will preapprove you for the program that best meets your needs and desires.

So if you are ready to get preapproved and buy that dream home AND you want to work with a Realtor who will actually help you through the whole process, give Robb a call at 317-657-8059 or shoot him an email at robb@yourrealtylink.com to set up your FREE buyers consultation.

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