Everyone knows that time is money, so let’s start with a timesaving tip. If you’re a homeowner who wants to refinance an existing mortgage, this information isn’t for you. The information you find here applies only to folks who haven’t bought a house yet.
Now, for all you wannabe homeowners, be advised that there’s a right way and a wrong way to start the home-buying process. The wrong way, astonishingly, is rushing out helter-skelter to gawk at houses you think you may want to buy.
Don’t get it wrong; knowing what’s on the market is important. It’s even more crucial to educate yourself so you can distinguish between houses that are priced to sell and ridiculously overpriced turkeys. If you don’t know the difference between price and value, you could end up paying waaaaaaaaaay too much for the home you ultimately purchase. (To find out everything you need to know about buying a home, check out Home Buying For Dummies, by Ray Brown and Eric Tyson [Wiley].)
But … first things first: If you can’t pay, you shouldn’t play.
The worst-case scenario
Suppose you’ve been looking at open houses from dawn to dusk every Saturday and Sunday for the past seven weeks. Just when you begin to think you’ll never find your dream home, it miraculously appears on the market.You immediately make an offer to buy casa magnífico, conditioned upon your approval of the property inspections and obtaining satisfactory financing. When the sellers accept your generous offer, the bluebird of happiness sings joyously.
Three weeks later, the bird croaks. The loan officer calls to regretfully advise you that the bank has rejected your loan application. The reason isn’t because you offered too much for the house. On the contrary, the appraisal confirmed that the property is worth every penny you’re willing to pay.
The problem, dear reader, could be you. Unfortunately, your present income and projected expenses may be out of whack. You may not earn enough money to make the monthly mortgage payments plus pay the property taxes and homeowners insurance without pauperizing yourself. Adding insult to injury, this depressing discovery is delivered to you after you’ve blown hundreds of dollars on property inspections and loan fees and put yourself through an emotional wringer for three weeks.
Now the good news: It doesn’t have to be this way. After you establish how much you can prudently spend for your dream home, the next logical step is to get yourself preapproved for a mortgage. Then you’re properly prepared to begin your house hunt.
Loan prequalification usually isn’t good enough
You can use two techniques to get a lender’s opinion of your creditworthiness as a borrower. One is the better way to go. The other is potentially a waste of your time and money and may even be grossly misleading.Let’s start by critiquing the second-rate method. Mortgage prequalification is nothing more than a casual conversation with a loan officer. After quickly quizzing you about obvious financial matters, such as your present income, expenses, and cash savings for a down payment, the loan officer renders a down-and-dirty guesstimate of approximately how much money he might lend you at current mortgage interest rates assuming that everything you’ve said is accurate. Most lenders graciously provide a prequalification letter suitable for framing or swatting mosquitoes.
Mortgage prequalification is fast and cheap. It rarely takes more than 15 minutes unless you’re the type who has trouble parallel parking.
Because the lender doesn’t substantiate anything you say, the lender isn’t bound by the mortgage prequalification process to make a loan when you’re ready to buy. When your finances are scrutinized during the formal mortgage approval process, the lender may discover additional financial liabilities or negative credit information that reduces your borrowing power. In that case, you end up squandering precious time and money looking at property you aren’t qualified to buy.
Mortgage preapproval vs. prequalification
After you read this information, you’ll understand why formally evaluating your creditworthiness is such a protracted process. Mortgage preapproval is significantly more involved than mere mortgage prequalification.Mortgage preapproval involves a thorough investigation of your credit history. In addition, the lender independently documents and verifies your present income and expenses, the amount of cash you have on hand, assets and liabilities, and even your prospects for continued employment. If you’re self-employed, the lender conducts a diligent analysis of your federal tax returns for the past couple of years.
Obtaining the credit report, verifications of income and employment, bank statements, and other necessary documentation usually takes at least a week or two. That’s time well spent. Getting preapproved for a mortgage gives you two huge advantages:
- You know how much you can borrow. Being preapproved for a loan is almost as good as having a line of credit when you start house hunting. The only thing the lender can’t preapprove is the house you buy. Because you haven’t begun looking at property yet, your dream home is still only a twinkle in your eye.
Be sure to stay in touch with your lender during your house hunt. The amount you’ve been preapproved to borrow is written on paper, not carved in stone. Lenders won’t give you a firm commitment on your loan’s interest rate until you actually have a signed contract to buy your dream home. If interest rates increase (or your employment income declines) after you’re preapproved for a mortgage, the loan amount decreases accordingly. By the same token, you can borrow even more if interest rates happen to decline (or you get a well-deserved pay raise).
- You have an advantage in multiple-offer situations. In a hot real estate market, you may end up competing with other buyers for the same property. Being preapproved is proof positive to sellers that you’re a real buyer. Your offer will be given far more serious consideration than offers from buyers who haven’t bothered to prove that they’re creditworthy.
Some lenders offer free loan preapprovals to prospective homebuyers as a marketing ploy to endear themselves to borrowers. However, others charge for loan preapproval. Don’t choose a lender only because you can get a freebie preapproval. Such a lender may not offer the most competitive rates, which could cost you far more in the long run.
