If the last seven years haven’t shown us what over-spending can do to an economy, I don’t think anything will. The economy and the real estate market has seen better days but luckily, the real estate market has shown a steady growth that will hopefully continue. Think back to 2000 – 2003 when home prices started to rapidly increase and then over the next few years, they skyrocketed and buyers where offering far more than the asking price of a home. We can now look at this situation and conclude that many of these buyers where over-paying and over-spending. Today, many of those homeowners have experienced a painful realization that they cannot afford the home and sadly, many of them have lost those homes.
Don’t let yourself ignore the important lesson of knowing what you “can afford” when buying a new home. That is why getting pre-approved through a bank, credit union or mortgage broker is not only a good idea, but a great idea. Knowing what you can afford before you start looking at homes will allow you to search in your price range and not fall in love with a home that you can’t purchase. At The Jim Allen Group, we recommend pre-approval to our clients so that they not only learn what they can afford, but to also get a better idea of their credit score and if there are credit issues that need fixing prior to making a home purchase.
What is the Difference between Pre-approval and Pre-qualification?
You may hear the terms pre-approval and pre-qualification and think they are they same, however, they vastly differ. Pre-qualification is different from pre-approval because a lender typically will not review your credit report when pre-qualifying. Thus, pre-approval provides better bargaining power since it is a solid commitment from the lender on what they will loan you, rather than an estimate. One important fact is that there may be a fee associated with pre-approval so be sure to ask in advance. Also inquire as to whether you have to pay the fee in the event your application is denied.
The Pre-Approval Process
If you are considering purchasing a home, it is a wise decision to get pre-approved. Ask others whom have already gone through the home buying process for recommendations of a lender or if you are working with a real estate agent, they may have some great resources to consider. You don’t have to go with the first lender you talk with. Shop around as many lenders offer different loan terms and its important that you are comfortable with whomever you choose.
Each lender has specific requirements on what you need however, most likely they will ask for the following items to complete the process:
1. Proof of Income: pay stubs for the past 3 months and your most recent W-2 Tax form; if you are self-employed you may need your tax returns from the past 2 years, business-related receipts and invoices, financial statements and a copy of your business license (if applicable).
2. List of Assets: material possessions such as a home, car, boat or large ticket items and liquid assets such as cash, stocks and bonds. If you have loans associated with these items, its important to provide the details (lender, account #’s, amount).
3. Bank Statements: recent bank statements to verify that you have available money for a down payment, and to ensure the absence of large deposits from non-employment sources such as gifts or loans (from friends or family members). You will most likely be required to bring bank statements from up to the last six months showing deposits, withdrawals and consistent transactions of funds.
4. Credit Report: the lender will get approval from you to pull your credit report/s. These reports will include your FICO score which will provide the lender an idea of your credit history and your credit risk. Your credit score is important as higher numbers will deliver better loan terms (lower interests rate). Review these reports to determine if there are any inaccurate details and if necessary, get these fixed to improve your score.
Once all the appropriate information is submitted, the lender will be able to determine how much they are “willing” to lend you. The rule of thumb for determining what you can afford to borrow is based on your debt-to-income ration (what you owe and how much you make) and taking into account your credit history and also your down payment. Lenders will then give you a pre-approval letter based on how much they are willing to lend you and that provides a buyer the knowledge that you have the funds available to purchase their home. Also important to know is how long the pre-approval letter is good for. Typically they are good for 90 – 120 days which means, you can safely purchase a home within the determined time frame without having to go through the process again. Each lender may have a different scenario, so always get the facts.
With pre-approval in hand, you can now enjoy your home search knowing exactly what you can afford without over-spending! With home prices more realistic and interest rates at historical lows, you should be comfortable with your decision for years to come!