You’ve read here before about the important distinction between a preapproval and a prequalification and why the distinction is important. First, when you make an offer on a home the sellers want to see how serious you are about the process and whether or not you’ve even talked to a mortgage company. Second, with a preapproval you can shop for a home with the knowledge that all you need next to do is find a property and provide a copy of your signed sales contract to your lender. Beyond that, here are three things you need to know about mortgage preapprovals.
Documentation. Be prepared to provide your fair share of paperwork. When a lender reviews an application for a preapproval the lender realizes there is no property as of yet but documents the loan application is if there were. Your credit report is pulled and credit scores examined. You’ll be asked to provide your two years most recent W2 forms along with recent pay check stubs covering a 30 day period. If you’re self-employed, you’ll need copies of your last two years of both personal and federal income tax returns. Bank statements showing sufficient funds for a down payment and closing costs must be provided.
Dating. Speaking of documentation, when a lender performs a preapproval the lender does so based upon the most recent documentation you have. If you’re asked to provide pay stubs and you find copies of some from a few months ago, that won’t work. They need to be within a 30 day period. So too do your bank statements need to be within that time frame. If you’re shopping for a home and it’s been three months since your preapproval was initially performed, while your preapproval letter may be okay for the sellers the lender will still update your file once you have identified a property.
Don’t Change. Once your preapproval is issued it’s important that you don’t change anything. Don’t rent another apartment. Don’t change jobs even if the new job pays you more. Switching employers means the mortgage company needs new pay check stubs and getting those new stubs covering a 30 day period can be a challenge as employers typically delay the first pay check. If you’re thinking of making any important changes while you’re shopping for a home, speak directly with your loan officer first.
A recent survey asked renters a multitude of questions in order to get a better handle on what motivates renters to become home owners and two matters stood out- saving enough for a down payment and credit questions. Renters have the opportunity to check on their own credit profile for free at a site supported by the three main credit repositories of Equifax, Experian and TransUnion. This site Yet far too often renters don’t check their credit and that can keep many from home ownership simply because there are mistakes on the report suppressing scores. However, the biggest obstacle by far was saving money for a down payment and closing costs.
As rents keep hitting record highs that also means renters have less disposable income to put back every month in a savings account. Mortgage lenders employ an ability to repay formula that compares gross monthly income with housing costs. Housing costs include amounts for principal and interest, property taxes and insurance. Lenders follow this debt-to-income ratio as part of the loan qualifying process. However, there is no such required ratio for rent. Instead, property managers or landlords accept a rental application, review a credit report and even review a pay check stub but there is no debt ratio requirement. This can mean tenants, even those with excellent credit, can get into a rental agreement where the rent is so high there’s very little left over each month.
Unless the renters are eligible for a VA loan or the property is located in a rural area where a USDA mortgage could work, there will be a down payment needed for a mortgage. Fannie Mae recently introduced the HomeReady loan which asks for 3.0% down and the FHA loan asks for just 3.5% down. That doesn’t sound like a lot when compared to a conventional mortgage and a 20% down payment but if your rent takes up more than half your monthly income that can be a barrier. Other living expenses take out the rest and then there’s entertainment to address. There doesn’t appear to be any resolution to this issue other than renters who do want to own a home to sign a lease agreement that leaves a little wiggle room and some for savings.
When you talk to your loan officer and get an interest rate update more than likely the loan officer will turn directly to the 30 year fixed rate loan. Why? Because it’s the most popular loan choice, that’s why. It’s also the most heavily advertised and promoted. When lenders quote and advertise a home loan program they also are required to quote the appropriate annual percentage rate, or APR. Lenders have multiple loan programs from which to choose from fixed to adjustable to variable but there really isn’t the time or space when doing so to quote every loan program across the board. Instead, the 30 year loan term is the most common and most familiar with borrowers. But are borrowers short-changing themselves when they only look at a 30 year term? Let’s look at why a 15 year mortgage can make sense.
There’s a tradeoff between the 30 and 15 year loan. The 30 year loan, because it’s spread out over a longer period, will have lower monthly payments compared to a 15 year loan on the same rate and loan amount. However, because it is spread out over 30 years, there’s a lot more interest given to the lender and it takes longer to pay down the mortgage. If you take a $300,000 loan and a rate of 4.0% over 30 years the monthly payment is $1,432. Halfway through the loan term, the balance is just over $193,000.
With a 15 year loan at 4.0% the payment is $2,219 and halfway through the loan term the balance is just over $191,000. To get to the same loan balance with the 30 and 15 year loan it takes 15 years for the 30 year loan and half that time with a 15 year.
You do need to notice the difference in monthly payments. The 15 year loan is noticeably higher than the 30 year but if savings on interest payments and paying down the loan balance is a priority then the 15 year loan term just might be your better choice.
Adjustable or Fixed? That’s one of the decisions you’ll need when considering a new mortgage either for a purchase or for a refinance. When rates are at relative lows and the expectation is to keep the property well into the future it can make sense to latch onto a fixed rate loan. A fixed rate loan is much easier to budget for as the home owner knows how much the mortgage payment will be throughout the life of the loan. It’s easier to plan for. Pick out a fixed rate term, lock in the rate and forget it. But does that mean an adjustable rate mortgage is rarely an option? Should borrowers ever even consider a variable rate loan? The answer, even in times of low rates, is yes. There are times when an adjustable rate mortgage can be beneficial.
Adjustable rate home loans can have an interest rate change at various points throughout the life of the loan. For a 1-year loan adjustable rate loan, the rate can change once per year based upon a preselected index and an added margin. If the index was 1.25 and the margin on the loan program was 2.00, adding the two together would result in an interest rate of 3.25% and would remain there until one year later. To protect the borrowers against any wild swings in the interest rate from one year to the next, adjustable rate loans have interest rate caps. If the rate cap is 2.00%, no matter how high or low the index would be one year later, the rate could not move more than the cap dictates. Borrowers select adjustable rate loans because the start rate is lower than what is found on fixed rate loans. That’s the advantage. Even if rates in general begin to climb over time, due to the caps in place it limits the movement of the rate and therefore the payment.
Today, most adjustable rate programs are found as hybrids which means the start rate on the loan is fixed for a predetermined period of time before turning into a loan that can change once per year. The most common hybrid is the 5/1 where the rate is fixed for five years. Other hybrid options include 3/1, 7/1 and 10/1. Hybrid start rates are also lower than fixed rate loans and can be a beneficial option, lowering monthly payments.
Ready to finally stop renting and buy your very first home? Current homeowners will tell you it was an exciting process to finally own their own place and quit sending their landlord rent money each month. And a pleasant surprise is that mortgage interest is actually tax deductible, reducing your annual income tax liability for those who itemize while rental payments have no such deduction. That said, how do you buy your first home?
Your first stop is to speak with an experienced loan officer. There are various loan programs available and your loan officer will suggest a few based upon your current situation. When you speak with a loan officer over the phone, be prepared to answer questions such as “How much do you make each month?” and “How much money do you have available for a down payment and closing costs?” There are loan programs that ask for nothing down such as a VA loan or USDA mortgage and there are those that you can put down more should that be an option for you.
Your loan officer will suggest getting preapproved. This means the lender reviews your current pay check stubs, bank statements and a credit report along with your submitted loan application. You don’t need a property already picked out in order to receive your preapproval letter. Some sellers won’t even consider your offer without one.
Once you get your preapproval letter, you can speak with a real estate agent about buying your first home. The agent will also ask you a series of questions such as where you might want to live as well as the price range you’re preapproved for. How many bedrooms do you need? Will you need a bigger place in the future? Are you looking longer term or perhaps just a few years for the first property? All of these questions might seem a bit overwhelming and while no one can accurately predict the future it gives your agent a road map to homes that meet your needs.
Once you find a property and your officer is accepted, your loan officer will take over from there. Just make sure you provide the documentation your loan officer asks for promptly to avoid any potential delays in the closing process. Buying your first home can be exciting as well as overwhelming for some, just work with your loan officer and ask questions as you go.