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  • Writer's pictureRebecca Richardson

What It Really Means to Be Pre-Approved For a Home Loan

Finding the perfect home can be an exciting adventure for new and veteran homebuyers alike. But before you start scrolling through options online, it’s important to figure out what a realistic budget is so you can shop smarter and make strong offers.

Part of this process is being pre-approved for a loan - this means determining how much money you can borrow from a financial institution (ie: a bank). Your lender asks you for a variety of information to determine what you can be approved for, how much you can realistically borrow, and what your interest rate may be.

This process is basically an application for your mortgage and an in-depth look at your finances. Here’s what you can expect to show to your lender:

  • Proof of Income and Employment Verification through W-2 Statements and Pay Stubs

  • Proof of Assets

  • Identification through your License and Social Security Number

  • Credit History through your Bank and Credit Card Statements

  • And more

This process isn’t just about your lender knowing how much they should expect to lend but as a buyer, you’ll have information to help you narrow down your options. That’s why going through the pre-approval process early on when you’re starting your home buying journey so your agent can help you more effectively.

After you’ve gone through the pre-approval process, you’ll receive a preapproval letter. Your real estate agent will want to see this before shortlisting options for you, to know that you are serious about your journey and that they show you options within your budget.

This letter also helps you when you find a home you love because by showing it to the seller, they’ll be reassured that you can indeed afford it and be more likely to consider your offer.

Another added benefit of going through this process earlier on is having time on your side. Different situations can come up during the home buying process that puts time constraints on the buyer and/or seller. Having this process done and dusted gets the bulk of the work done so when your offer is accepted, you can quickly move on to the closing and moving process.

But here are a few things to keep in mind about the pre-approval process.

This process results in more than just an estimate - it’s an offer by the lender to loan you a specific amount, based on their terms. This offer can also expire after a certain number of days, depending on the lender. Some potential buyers opt for a pre-qualification instead, before the pre-approval, to get an idea of if they’re financially ready to purchase a home. This process is more informal and the lender simply estimates whether or not you would qualify for a mortgage and how much you may be able to borrow.

Now let’s say you’ve gone through the pre-approval process and you know the maximum payment you can expect from the bank.

But the reality is you're not actually pre-approved for a loan amount, you are pre-approved for a maximum payment. When the lender or real estate agent is looking at your application or taking any of your other monthly debts - things like student loans, cars, credit cards - adding on the mortgage payment and then making sure that that total amount does not exceed the debt to income ratio for a particular program.

As an example, let’s say your maximum mortgage payment is $1,750 and that includes the other debts you already have. On a single-family home marketed at $350,000 with 5% down and a 3% interest rate, that should have your payment under that $1,750 mark.

However, let's say that you're looking at a condo or townhome. Most of the time, there are going to be HOA dues included and that will push up your overall cost. Let’s say that the HOA costs are around $250. If you add that onto your $1,750 payment, you're over your limit.

So if we reverse engineer your maximum payment factoring in things like HOA dues, that's probably going to have you closer to a purchase price of around $280,000. That's why there's a big swing depending on the type of property that you're looking for and then also the sales price and associated costs - including taxes, insurance, and HOA dues.

The thing to keep in mind is when you're shopping for a home is to look within your range but always stay in constant contact with your lender when you're thinking about a specific home. They’re going to want to run the payment for that home and make sure that it fits within your budget so there are no issues with final approval.

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