How Does the Mortgage Process Work?
The vast majority of home buyers purchase their dream home with financing, and that means applying for a mortgage. Don’t believe everything you’ve been warned about, however. The loan application process is more user-friendly, automated and transparent than many property novices are aware. Here are the key steps to address, and tips for getting ahead of the paperwork.
Is Pre-Qualification Essential?
Beware of the distinction between pre-qualification for a loan and pre-approval. They are not the same, and you may decide to skip pre-qualification altogether. Pre-qualification is simply a perfunctory, non-binding review of your financials by a financial advisor or lender. It’s informal and not based on any third-party credit reports, so it carries little weight with sellers. It may be useful, however, if you are coming to the mortgage approval process with no knowledge whatsoever of your eligibility and want to confirm that you’re at least in the right ballpark before proceeding.
Pre-Approval Establishes Your Budget
Pre-approval, on the other hand, involves a more robust process for establishing your mortgage eligibility. In this case, the lender will formally examine your financials to see if you meet the lending criteria. You’ll receive a clear picture of how much you can borrow, thus what price range you can search within. During the pre-approval process, the lender will look at the following:
- Credit Report. Your credit score represents a key component of the approval process, but don’t believe the myth that you need a perfect credit score. FHA loans, for example, typically offer a lower threshold.
- Income. You’ll need to show two years of W-2 statements and pay stubs.
- Assets. Get together your bank statements and other statements for any investments or additional income.
The lender will also establish your Debt-to-Income Ratio, calculated according to your income in relation to your expenses and existing debt burden. It’s a myth that you can’t get a mortgage if you’re already carrying debt. Many homebuyers, particularly millennials, have years of student loan debt to repay. As long as your debts do not exceed 36% of your income (the maximum ceiling is 43%), you should be within the acceptable range for a mortgage. (Pull your credit report with SmartCredit, and take advantage of easy Action buttons that let you ask questions, resolve errors and make a plan to achieve your best score).
Once pre-approval is complete, the mortgage lender will establish the loan amount you can qualify for. Realistically, you should have your pre-approval in place and ready to go before you start approaching sellers.
Begin House Hunting
Let the fun begin. With your pre-approval locked in, start searching properties listed within your price range. Bear in mind, however, that many online listings show prices that differ from the seller’s actual asking price. Now is the time to engage the services of a realtor. Not only can they offer a powerful negotiating resource, but they can also mine their network and local knowledge for listings that may not even be on the open market.
Found It? Make an Offer
Making a formal offer to the seller is a great landmark to reach, but there’s still a ways to go. Any sale will be based on so-called contingencies, which are the conditions that must be fulfilled in order to complete the transaction. These involve appraisal by the mortgage lender, home inspection and mortgage approval for the buyer. This is also the moment to make your down payment, which will be placed in escrow. You might have heard that a 20% downpayment is the minimum, but that is not always true. With an FHA loan, for example, you can put down as little as 3.5%.
Applying for a Mortgage
The paperwork now begins in earnest. You’ll have assembled many of the documents required at pre-approval, but otherwise this is the moment to collect a stack of personal, professional and property records to apply for a mortgage. You’ll need the following:
Mortgage application dossier
- Employment records and pay stubs, going back at least two years.
- Bank statements, pension statements and social security records.
- Statements for any savings, investments, assets or other sources of revenue.
- Statements for any car loans, credit cards or other debts and borrowing.
While you’re busying yourself with these, your realtor will be assembling the property file for full details on the property size, taxes, HOA fees and so on. These are usually available in court and public records.
Once all documents are submitted to the lender, you must receive a Loan Estimate within three days. This will detail the terms of the loan, including interest rate, closing costs, monthly payments and any penalties that apply for early repayment. For your part, you then have ten days in which to issue an Intent to Proceed (agree) or reject the offer and keep searching.
Loan Processing and Underwriting
The documents you and your realtor have submitted to the lender now pass onto the verification stage. There is not much for you to do other than wait while your lender confirms your credit report, title report and mortgage appraisal. In some cases, the appraisal amount (the mortgage lender’s valuation of the property) is less than the seller’s asking price. If this happens, you can pay the difference, renegotiate with the seller or walk away from the deal.
The final step is for all documents to pass to the Underwriter. This figure is the gatekeeper for the loan approval. Based on their assessment of the loan estimate, borrower file and property file, they will approve or reject the mortgage application. If there are any red flags in your credit report or borrower file, such as delinquent payments or insufficient proof of income/assets, they may request a written explanation or further proof. Try to anticipate these from the outset so that you have the documents ready.
Assuming the Underwriter has approved the mortgage application, your file will be sent to the appointed attorney, who will, in turn, summon you to a closing ceremony of sorts. This requires your signature (and thorough review) of a substantial pile of documents, as well as payment of the closing costs, which cover settlement fees and any prepayments for homeowners insurance, mortgage insurance or taxes. Although closing costs can be included in the overall loan, this may not always be the case, so budget for up to 5% of the property purchase price.
With the deal inked and the property title transferred, you will emerge from closing with a Promissory Note (your IOU to the mortgage lender), Closing Disclosure and the Deed of Trust. And of course, you will be the owner of a new property.