Pre-Qualification -vs- Pre-Approval

The first step in buying a home is to talk to a lender and get pre-qualified for a mortgage, BEFORE you start looking. A lender can help you decide how big a house payment you can afford. A lender should also estimate closing costs and total cash (including down payment) that you will need to buy a property.

What is the difference between pre-qualifying for a loan, and formal loan approval? An informal discussion with a lender is considered pre-qualifying, whether done in person or over the phone. The lender will compare your gross monthly income with your expenses. They will ask what you will use for a down payment, and possibly check your credit history. Then, working with you, a lender can recommend the amount of house payment you can afford.

Pre-approval for a loan comes after you have actually completed a loan application and provided your lender with the required documentation. A credit report will be ordered. The lender may say you are pre-approved at that point, but until the loan has been approved by the underwriter, it is not official. The loan is also subject to your purchasing a home. Negotiating for a home will be easier if you have a pre-approval certificate from your lender.

Documentation needed at this point is usually:

Paycheck stubs
W-2 Forms for last 2 years
If self-employed, two years of tax returns
2-3 months of bank statements
Copies of personal tax forms for the last two to three years.
Copies of brokerage account statements for 2-4 months, plus any other major assets, such as an RV, second home, etc.
Copies of your most recent 401(k) or other retirement account statement.
Documentation to verify additional income, such as child support, pension, etc.
Credit card account numbers and outstanding balances.
Lender, loan number, and amount owed on other installment loans-student loans, car loans, etc.
Addresses where you lived for the last five to seven years, with names of landlords, if appropriate.

Final approval of a loan is given once your offer on a property has been accepted, and the amount of the loan is decided upon. Loan approval is one of the dates on a contract, and if you cannot get the approval, it provides you with a legal way to get out of the contract without losing your earnest money.

Many different loan programs are available, and each lender has their own version. The fixed rate mortgage is the most common type of loan. The interest rate stays the same throughout the term of the loan, which can be from 10-30 years. While interest rates are still relatively low, this can be an attractive type of loan.

An Adjustable Rate Mortgage (ARM) links the interest rate to a financial index, such as a Treasury Security or a "cost of funds index". This means your monthly payments can vary over the live of the loan because the interest rates can change monthly, annually, or once in a while. Some ARMs have a cap on the interest rate increases, to protect the borrower.

A Balloon Mortgage is a loan where the final payment is substantially larger than previous payments, and which repays the debt in full. Balloon payments are frequently used in second mortgages (to keep installments low when paying first and second mortgages concurrently). A loan which provides for a lump sum payment at the end is also referred to as a partially amortized loan. The advantage of a balloon mortgage is an interest rate that is lower than a conventional 30-year mortgage.

A VA loan, or a Veterans Administration loan, is a government-sponsored mortgage assistance program, also known as GI loans. Eligible veterans can use a VA loan to purchase a home with little or no down payment and a low interest rate. The VA program encourages lending institutions to make loans by guaranteeing part of the loan in the event of default. VA guaranteed loans can be combined with second mortgages and are assumable upon qualifying by any future buyer.

The Federal Housing Administration (FHA) is a federal agency established in 1934 to encourage improvement in housing standards, provide an adequate home-financing system and become a stabilizing influence on the mortgage market. FHA does not build homes nor lend money directly; they insure loans made by approved lending institutions on real property. This usually makes the down payment lower than convention loans. Should the homeowner default on the mortgage; the lending institution will not incur any significant losses since FHA has insured the lender against that risk.

A second mortgage or "combination loan," can be used to help a buyer with a portion of the down payment. When a borrower does not have the typical 10-20% for a down payment, a first and second mortgage can be combined. Instead of the buyer coming up with 20% of the purchase price for a down payment, the buyer puts 10% down and borrows the remaining 10% on a second mortgage.

With all the different types of loans available today, be sure you find a loan that fits your needs. Here are some questions to ask a prospective lender when shopping for a loan:

Which type of mortgage plan do you recommend for us?
Are your rates, terms, fees, and closing costs negotiable?
Will I have to buy private mortgage insurance? If so how much will it cost and how long will it be required? NOTE: Private mortgage insurance usually is required if you make less than a 20 percent down payment, but most lenders will let you discontinue the policy when you've acquired a certain amount of equity by paying down the loan.
Who will service the loan? Your bank or another company?
What escrow requirements do you have?
How long is your loan lock-in period (the time that the quoted interest rate will be honored)? Will I be able to obtain a lower rate if they drop during this period?
How long will the loan approval process take?
How long will it take to close the loan?
Are there any charges or penalties for prepaying the loan?

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Pre-Qualification -vs- Pre-Approval