By Daniel Bortz
Getting a mortgage is easy, right? You’ve seen the TV commercials and the billboard ads touting promises like, “Get approved for a mortgage today!” Well, sorry to break the news, but the reality is that obtaining a home loan isn’t just one mouse click or phone call away.
There are a number of hoops to jump through and hurdles to cross before a mortgage lender will issue you a loan. To switch metaphors, it’s less of a sprint, more of a triathlon—and it’s easy to overlook an important stage or two as you move toward the finish line.
Curious what home buyers often miss, much to their chagrin? Here are five essential steps that many people don’t realize are needed for a mortgage.
1. Get pre-approved
In any highly competitive housing market, it’s akin to self-sabotage not to get pre-approved before making an offer on a house.
Pre-approval is a commitment from a lender to provide you with a home loan of up to a certain amount. This will set your home-buying budget, and also show sellers that you’re serious about buying when it comes time to put in an offer. In fact, many sellers will accept offers only from pre-approved buyers, says Ray Rodriguez, New York City regional mortgage sales manager at TD Bank.
Mortgage pre-qualification should not be confused with pre-approval. Pre-qualification is based solely on verbal information you give a lender about your income and savings—meaning that it shows how much you could theoretically borrow. But make no mistake, it’s no guarantee. Pre-approval, on the other hand, means the lender has already done its due diligence and is willing to loan you the money.
How to do it: To get pre-approved, you’ll have to provide a mortgage lender with a good amount of paperwork. For the typical home buyer, this includes the following:
- Pay stubs from the past 30 days showing your year-to-date income
- Two years of federal tax returns
- Two years of W-2 forms from your employer
- 60 days or a quarterly statement of all of your asset accounts, which include your checking and savings, as well as any investment accounts, such as CDs, IRAs, and other stocks or bonds
- Any other current real estate holdings
- Residential history for the past two years, including landlord contact information if you rented
- Proof of funds for the down payment, such as a bank account statement. (If the cash is a gift from your parents, you need to provide a letter that clearly states that the money is a gift and not a loan.)
2. Ace the home appraisal
Lenders require a home appraisal before they’ll issue a loan, because the home you’re buying is going to serve as collateral. If you can’t make your mortgage payments, the lender will have to foreclose upon your home, and then sell the property to recoup its costs. Which is why it wants to make sure the property is worth the amount of money you’re paying for it.
If the home’s appraised value is the same as what you’ve agreed to pay, you’ve passed the appraisal. If the appraisal comes in at a figure higher than what you’re paying, you’re golden—in fact, you’ve gained instant equity! But, if the appraisal comes in lower than what you’ve agreed to pay, you have a problem.
How to do it: A lender won’t loan more than a home’s appraised value, which could leave you, the borrower, to cover the difference, says Chris Dossman, a real estate agent with Century 21 Scheetz in Indianapolis. But if you’re unwilling or able to do that, you have a few options:
- Negotiate with the seller. For the appraisal to pass, the seller may agree to lower the sales price. Of course, this might require some negotiating by your real estate agent with the sellers agent.
- Appeal the appraisal. Sometimes called a rebuttal of value, an appeal involves your loan officer and agent working together to find better comparable market data to justify a higher valuation. If you file an appeal, the appraiser will review the information and then make a judgment call on whether or not to adjust the info.
- Order a second appraisal. If you believe the initial appraisal is significantly off base, for whatever reasonmaybe the appraiser overlooked a good comp or wasnt familiar with the local housing marketyou can order a second appraisal. Youll have to pony up for the expense, and appraisals can range between a few hundred dollars and $1,000, depending on the area.
- Walk away. This is a total bummer, but it may not be worth overpaying for a home, says Dossman.
3. Keep your credit score stable while under contract
Depending on the loan program, lender, and applicant’s specific credit history, the minimum credit score necessary to buy a home varies. The minimum requirement could be as low as 580 for a Federal Housing Administration (FHA) loan, or as high as 660 for a conventional loan, says Theresa Williams-Barrett, vice president of consumer lending and loan administration for Affinity Federal Credit Union. However, lenders vary in their requirements.
The caveat, though, is that your credit score must remain stable while you’re under contract on a house. Why? Because the lender’s final clearance and a loan commitment are subject to a last-minute credit check (and other verifications) shortly before closing.
How to do it: To avoid jeopardizing your final loan approval, follow these guidelines:
- Dont open new credit accounts. Applying for a new credit card can ding your score, says Beverly Harzog, a consumer credit expert and author of The Debt Escape Plan, because it results in a hard inquiry on your credit report. Buying a car, boat, or any other large purchase that has to be financed can also dock your score.
- Dont close old credit accounts. Closing an old account can hurt your debt-to-credit utilization ratioa term for how much debt youve accumulated on your credit card accounts, divided by the credit limit on the sum of your accounts. This ratio comprises 30% of your credit score. By closing a credit card account, you reduce your available creditmaking it more difficult to keep your debt-to-credit utilization ratio below 30% (the recommended percentage).
- Dont miss a credit payment. Even one late payment can cause as much as a 90- to 110-point drop on a FICO score of 780 or higher, according to Credit.com.
4. Review the closing disclosure form
Lenders must provide borrowers with a closing disclosure, or CD, at least three business days before closing. Essentially, the CD is the official follow-up to a more preliminary document you received when you first applied for your loan, called the loan estimate, or LE (also known as a good-faith estimate).
The LE outlined the approximate fees you would be expected to pay if you move forward with a lender to close on a home. But your closing disclosure is the real deal—it outlines exactly what fees you’re going to pay at settlement. You have to scrutinize it carefully, especially considering that a recent survey of real estate agents by the National Association of Realtors® found that half of agents have detected errors on CDs.
How to do it: Ask your real estate agent to sit down with you and compare the CD and LE. Here’s a list of things to triple-check:
- The spelling of your name
- Loan term (15 years? 30 years? Something different?)
- Loan type (a fixed-rate or adjustable-rate mortgage)
- Interest rate
- Cash to close amount (down payment and closing costs)
- Closing costs (fees paid to third parties)
- Loan amount
- Estimated total monthly payment
- Estimated taxes, insurance, and other payments
5. Pass the underwriting process
Before your lender issues final loan approval, your mortgage has to go through the underwriting process. Underwriters are like real estate detectives. It’s their job to make sure you have represented yourself and your finances truthfully, and that you haven’t made any false or misleading claims on your loan application.
Underwriters will pull your credit score from the three major credit bureaus—Experian, Equifax, and TransUnion—to make sure it hasn’t changed since you were pre-approved. They will also review the appraisal of your prospective home to make sure its value matches the size of the loan you are requesting, and check that you haven’t taken on any new debts.
Many underwriters will also contact your employer to verify the job and salary that you listed on your loan application. This sounds like a basic step, but you’d be surprised how many people lie on their mortgage application.
How to do it: This one’s pretty simple. Assuming you’ve been diligent about keeping your credit score, job status, and debts stable, you’ll pass with flying colors. If the underwriter has a question, don’t panic—the best thing you can do is respond with prompt and complete information. Your agent is also there to help you troubleshoot any issues.
For more smart financial news and advice, head over to MarketWatch.