Mortgage rates continue to change, but they remain historically low, even with COVID-19 introducing volatility into current home interest rates. If you are considering buying a home, it might be a good time for you to lock in one of today’s historically low home mortgage rates. Yet, uncertain times have also caused lenders to mitigate risk by raising credit requirements and increasing down payment requirements.
Before you jump into a mortgage loan application head first, you can start with the preapproval process. This gives you a solid glimpse into the likelihood of securing a final approval with today’s home mortgage rates. We’ve developed this guide for you to learn more about the current mortgage landscape, understand the preapproval process and requirements, and help you work towards meeting all the qualifications for preapproval, eventually leading you into homeownership.
What Are Mortgage Rates Today?
COVID-19 has forced lenders to deal with an abundance of forbearance and refinance requests causing today’s mortgage rates to rise and fall from week to week. Yet, rates for home loans consistently below four percent and sometimes in the low three percent range. Homebuyers who go to their local credit union can sometimes lock in rates below three percent, as credit unions typically offer better mortgage rates than big banks. This is especially true of 10-year fixed mortgages.
What Is a Mortgage Pre-approval?
The term pre-approval might cause you to think it is a promise from a lender for a mortgage. This is not the case. A mortgage pre-approval refers to the letter you get from your lender after you go through the pre-approval process. Your lender has evaluated your financial situation and determined your maximum home loan amount, the amount of a monthly mortgage payment you could pay, and the interest rate for your loan. Once your lender pre-approves you for a mortgage, you can let your real estate agent and sellers know you are working with a lender and your lender is willing to lend you money.
What Is the Difference Between Pre-qualification and Pre-approval?
When you begin looking for the perfect home, you will hear the words pre-qualification and pre-approval thrown around quite frequently. Many times people conflate them as the same thing. In fact, a mortgage pre-qualification and a mortgage pre-approval are two different things. The difference between the two is the extent to which your lender looks at your financials. When a lender gives you a pre-qualification, they use the information you provide without doing any digging and give you a rough estimate of a mortgage amount. On the other hand, lenders thoroughly review your financial information, verify the numbers you’ve provided, pull your credit, and evaluate everything before they give you a pre-approval mortgage amount.
What Are the Benefits of a Mortgage Pre-approval?
Some homebuyers begin looking at homes without a pre-approval. They find one they like and then search for a lender, foregoing the entire pre-approval process. This isn’t the ideal way to approach buying a home. Mortgage pre-approvals offer several benefits to homebuyers. They include:
- Preparation. You have the opportunity to discuss the many loan options you have and consider payments, so you know your target monthly payment will be in your budget.
- Eliminate Surprises. When your lender pulls your credit, any potential issues will come up. This gives you the opportunity to fix any blemishes and increase your credit score, so you get a better interest rate.
- Determine your price range. Getting a mortgage pre-approval helps narrow your search for the perfect property because you know the maximum amount you can borrow. Finding the perfect home and then finding out you cannot afford it is a heartbreaking experience you can avoid.
- Speeds Up the Loan Process. After a pre-approval, your lender will have most of your information in their system, so once you make an offer on the home you want to buy, the loan process goes more quickly.
- Gives You Credibility with Sellers. When you show sellers a pre-approval letter, they know you are serious about buying and also feel confident you can get funding if they accept your offer. A mortgage pre-approval can also give you a leg up when sellers receive multiple offers. All things being equal, sellers will accept an offer from someone who has been pre-approved by a lender. In some cases, sellers might even accept a slightly lower offer with a pre-approval letter instead of the higher offer without pre-approval.
When Should I Get a Mortgage Pre-approval?
Getting a mortgage pre-approval is one of the first steps of buying a home, but you have to do some preparation before you jump into homeownership. Financial guru, Dave Ramsey, who is famous for his debt-free approach to life recommends you are ready for a mortgage after you do the following:
- Pay off all of your debt, including student loans, car loans, credit cards, and any other revolving lines of credit.
- Create an emergency fund with three to six months of expenses so you are prepared if you lose your income after you buy a home.
- Save enough money for a down payment. Ideally, you want to put 20 percent down to avoid paying private mortgage insurance (PMI), but you might be able to qualify for a mortgage with a lesser amount.
Ultimately, you should get a mortgage pre-approval when you know you have decent financial health and that you can afford the payment. These are the things lenders will look at when they decide whether to pre-approve you.
What Do I Need for a Mortgage Pre-approval?
As mentioned above, your lender will thoroughly review your finances during the pre-approval process. This requires you to provide proof for all the information you provide as well as meeting certain financial benchmarks. Below we provide a list of the items—tangible and intangible—that you need for a mortgage pre-approval.
Proof of Income/Employment
Lenders want to give money to borrowers who have a dependable income, typically achieved by stable employment. Your lender will likely call your employer to verify your salary and employment. If you’ve changed jobs in the past two years, it’s likely your lender will also call your previous employer. You will need to provide the following items for a mortgage pre-approval to prove your income and employment:
- W-2 forms from the last two years
- Recent payroll stubs that include your current income and your year-to-date income
- Proof of additional income including spousal support and work bonuses
- Tax returns from the last two filing years
Self-employed Home Buyers
If you are self-employed, you will have to jump through a few more hoops to prove your income to your lender. In addition to providing complete copies of tax returns for the last two years, you must provide enough information for your lender to consider the following factors, according to Fannie Mae, the government-sponsored organization that finances most mortgages:
- The stability of your income
- The nature and location of your business
- The demand for the product or service you offer
- The financial fitness of your business
- Your ability to pay the mortgage based on continued income from your business
Credit requirements vary among lenders and can change with current events, such as the arrival of a global pandemic like COVID-19. Most lenders want borrowers to have a minimum credit score of 620 to qualify for a conventional mortgage. You can get the best mortgage rates when your credit is above 760. If you are a first-time homebuyer or a veteran, you can qualify for a loan from the Federal Housing Administration (FHA) or the Veterans Administration (VA). These programs sometimes work with homebuyers whose credit is below 620. You will have to speak with your lender to find out the best loan options based on your credit score. It’s likely that if your credit is lower than 580, you won’t qualify for a mortgage.
Your debt-to-income (DTI) ratio is the comparison of your monthly income to all your monthly bills. Lenders include credit card payments, loan payments, car payments, and your mortgage in your DTI. According to the Consumer Financial Protection Bureau, lenders usually want a DTI below 40 percent, but prefer to see your DTI at 30 percent or below. If you’ve paid most or all of your debt before seeking mortgage preapproval, you won’t have a problem with your debt-to-income ratio. If you still carry some debt, your lender can advise you on their preference and counsel you on how to meet their requirement.
Industry-standard is a 20 percent down payment of the purchase price of the home, but some loan types allow a lower down payment. Lenders require buyers to carry private mortgage insurance (PMI) when their down payment is less than 20 percent. The general rule of thumb is that the better your credit and DTI, the lower down payment the lender might accept. The exceptions to this rule are FHA and VA loans; FHA loans require as little as 3.5% down and the VA has zero down programs for veterans. If you haven’t saved for down payment, you can get the money from a friend or family member; however, your lender needs verification that the money is a gift, not a loan.
Proof of Assets
Your lender wants to know that if you borrow money for a home mortgage, you will be able to make the payments. Additionally, they also want to know that your home purchase will go through once you make your offer. For pre-approval, you must prove your assets with bank statements, brokerage statements, retirement account statements, and any other relevant financial documents. They will check to make sure you have the funds for a down payment, closing costs, and cash reserves to make your first few mortgage payments.
Stages of the Mortgage Pre-approval Application Process
Filling out a mortgage pre-qualification application is the first major milestone of the mortgage loan application process. Once you’ve provided your lender with the above items, you will proceed through some other stages until you are a few steps closer to closing on your new home. Here’s what to expect:
- Your lender will submit your application for pre-approval with required documents to an underwriter, who will respond in one of four ways to your application: approval, denial, approval with conditions, and suspension, which means you need to provide more information before the underwriter can make a decision. Mortgage pre-approval typically comes back as ‘approved with conditions,’ if you meet the credit requirements.
- You have to finalize your loan before your pre-approval expires or you won’t get the rate.
- As you begin your property search, you also need to work on satisfying any of the underwriter’s borrowing conditions so your loan will get approved for closing. Conditions typically include providing additional documentation, providing explanations for abnormal items in your credit or employment history, and providing verifications. You typically must provide updated account statements prior to closing.
- Once you find a home you like, you make an offer, and the seller accepts the offer, you need to wait for the home to be appraised.
- Assuming the home appraises and your financial information hasn’t changed, you will be on the fast-track to closing because you had a mortgage pre-approval.
We Stand for You at Dane County Credit Union
What mortgage rates are today, might be different tomorrow. If you are looking to buy a home, don’t miss out on great interest rates that can save you money each month. Dane County Credit Union has served the residents and employees of the Greater Madison area since 1935. Our Member Services team would love to meet with you, discuss the home mortgage options that are right for you, and help you embark on the mortgage pre-approval process, so you can begin to search for the perfect home. Contact Dane County Credit Union today online or at 800 593-3228.