
A: There are two phases to securing a mortgage.
Imagine the lending market as sort
of trying to set up a friend on a date. You tell your friend about the partner
you have in mind for them, and based on what you tell them, they decide if that
person is worth a date. They're considering the possibility of the date,
assuming everything you say is true. If you tell your friend about the
potential date's persistent body odor problem, they might choose to say no. If
you tell your friend about their beau-to-be's interesting job, sense of humor
or winning smile, they'd probably set up a date to see for themselves. That's
part 1.
Of course, your friend doesn't go
immediately from your description to wedding bells. First, they have to
actually date and get to know each other. Your friend has to see if the
qualities you described are actually true and make sure there's nothing hiding
beneath the surface that would rule them out. That's part 2.
While it does make for some
confusion, lenders may refer to either part 1 or part 2 as pre-approval, and
the other as pre-qualification. Rather than focusing on the labels, focus on
the steps involved and what the steps mean. We'll keep calling them "part
1" and "part 2."
What do I need for part 1?
In part 1 of the process, you
describe your financial situation to a potential lender. Usually, this
information includes salary, savings and current debts. The lender may or may
not pull your credit score at this point. Based upon that information, the
lender will make a determination about the kind of loan you might qualify for,
assuming everything you've said is true.
You don't need to prove anything
at this point. It can be done over the phone, over the Internet or in person
and no documentation is required.
During Part 1, you might want to
compare possible mortgage rates. There's a lot less paperwork involved, so it's
much easier to ask a lender to run through a variety of scenarios. You can look
for a loan situation that combines the monthly payment, interest rate, term and
down payment where you have the most comfort.
Part 1 can be completed early in
the house shopping process. In fact, it makes sense to do this before you view
the first house. That way, you won't fall in love with a house you can't
possibly afford or convince yourself to settle for a house that doesn't really
meet your needs. This also gives you the chance to straighten out any potential
kinks in your financial situation before starting part 2. Don't worry about
multiple checks on your credit if necessary. Credit bureaus lump mortgage
inquiries within 30 days together as 1 inquiry, so they won't adversely affect
your credit score.
It's important to note that
pre-qualification is not a guarantee of a loan. To continue our example from
above, your friend agreeing to a first date does not mean you get to start
planning a wedding! Completing part 1 is a way to get an idea of how much you
can afford to spend during your house hunting, as well as a way to show
potential sellers that you're serious. Completing part 1 illustrates to a buyer
that you are already part of the way through the lending process, and it's less
likely that your financing will fall through.
What do I need for part 2?
Part 2 is where the paperwork
starts to fly. At this point, a lender is deciding whether or not to issue you
a loan. Successfully completing part 2 means a lender is ready and willing to provide
you with a loan up to a specified amount.
To navigate this step, you'll need
to prove everything you claimed in part 1. This means you need to provide tax
forms to substantiate your income and account statements to verify your
savings. You'll also need to sign a variety of forms giving your lender or
their agents the power to talk to employers, landlords and the IRS about your
financial security.
Generally, lenders will want tax
returns for the past 2 years, including supporting documents like W-2 forms. If
you've switched jobs a few times in that span, you may need to go further back
to demonstrate consistent employment. If you're an independent contractor or
own a small business, documentation requirements are significantly steeper.
You'll need to provide enough financial disclosure to show lenders that you can
make the payments.
Completion of part 2 is a
conditional approval for a loan. If the house you're buying passes appraisal,
you will get financing on the terms you've agreed upon with your lender. The
paperwork is a bit more cumbersome, so you don't want to do this multiple
times. Only complete this step with a lender you're going to borrow from.
Part 2 is best to complete before
you make an offer, especially in competitive markets. A letter of
prequalification or preapproval that shows your financing is in place does a
lot to reassure sellers that your offer will survive until closing. If you're
on the fence about what house you'll put an offer on, this process can still be
completed with the property identified as "to be determined".
Don't worry if this process seems
confusing. You'll be working with a qualified mortgage professional who deals
with it every day and can answer all your questions. One of the benefits of
working with Destinations Credit Union, an institution you trust, for your mortgage is that it clears your
mind to focus on the important stuff, like where to put the sofa!
SOURCES:
http://www.consumerfinance.gov/askcfpb/127/Whats-the-difference-between-a-prequalification-letter-and-a-preapproval-letter.html
http://www.myfico.com/crediteducation/creditchecks/inquiries.aspx
http://www.zillow.com/mortgage-learning/pre-approval/
http://www.investopedia.com/terms/p/preapproval.asp
http://www.investopedia.com/articles/basics/07/prequalified-approved.asp
http://www.consumerfinance.gov/askcfpb/127/Whats-the-difference-between-a-prequalification-letter-and-a-preapproval-letter.html
http://www.myfico.com/crediteducation/creditchecks/inquiries.aspx
http://www.zillow.com/mortgage-learning/pre-approval/
http://www.investopedia.com/terms/p/preapproval.asp
http://www.investopedia.com/articles/basics/07/prequalified-approved.asp
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