Before you can even think about looking for a home you need to be pre-approved. A pre-approval is a preliminary approval based on your credit score, projected down payment and review of your debt in relation to income. It is not an official bank approval but rather the anticipation of one. The final approval includes not only personal documentation but the appraisal, title and insurance as well. Where many buyers get confused is thinking their pre-approval number is the same as their budgeted number. The pre-approval is based on the available down payment, as well as the total debt to income ratio. Many times, the number you are approved for is not the same as what you are looking to pay every month. Before you start your house hunting search you need to talk to a bank or mortgage broker and get pre-approved. Here are three most important items of any pre-approval.
Credit Score:Your pre-approval starts with your credit score. Everything in the process revolves around the middle score of the three reporting credit bureaus; Experian, Transunion, and Equifax. The higher the score the more flexibility you have with down payment and interest rate options. The minimum middle score required is typically a 580 with some banks as low as 550. On the high side anything over a 700 gives you the best rates and most program options. It is a good idea to go to one of the many free credit report sites prior to meeting with a lender just to get an idea of where you stand. In some cases, there are things you can do to give your score a quick boost to get you over a numerical threshold if needed. Discovering any outstanding collections, charge offs or judgments now can help get your score where it needs to be when you are ready to make an offer.
Down Payment:Your available down payment is the second consideration in the approval process. It is important to remember that your down payment also includes your closing costs, prepaid property taxes and insurance. On every purchase your lender holds reserve funds in escrow for your property taxes. Depending on when you close there can be as many as eight months of taxes, or more, that is required at closing. This number could end up adding thousands of extra dollars to the cash needed at closing. You will also need money for attorney fees including title search & insurance, lender fees, origination fees and appraisal fees. During the initial application your lender or broker will give you an idea of exactly how much money is needed and what kind of program your down payment amount fits into.
Debt to Income:Strong income does not guarantee approval. You can make a significant income but if your debt is too high you won’t get approved. Lenders look at what is called a debt to income ratio. Simply put, they add up all the monthly liabilities on your credit report in addition to the proposed monthly mortgage payment. This number is divided by your gross monthly income. If the number is higher than 45% you may have a hard time getting approved. Some lenders will go to 50% total debt to income, but usually not a percentage higher. This is why getting a copy of your credit report before your start the process is important. There may be accounts you can pay down, or off, to get your debt to income below approval guidelines.
If you are serious about buying a home, you need to get pre-approved. Don’t wait until you find the house of your dreams to reach out to a lender. What is stopping you from getting pre-approved today?