Why You Should Get a Mortgage Pre-Approval and How to Qualify for a Mortgage
Shopping for a home without a mortgage pre-approval is like going to a marathon without wearing running shoes. Yet every day many homebuyers start their home search not knowing how much they can afford or even if they qualify for a mortgage.
Many people wonder…
What is a mortgage pre-approval and why don`t I just get a mortgage approval instead?
A mortgage pre-approval is a commitment from a lender that assures you, the sellers, and real estate agents that you have to ability to complete the purchase of a home up to a specific amount; more importantly, you will be able to know exactly how much mortgage you can get approved for.
For the mortgage approval, you’ll need to have purchased a property. Why? Because mortgages are tied to properties. If you offer too much money for a property you might not get approved for a mortgage even if you were pre-approved for that same amount.
Here are three reasons why every home buyer should get a mortgage pre-approval before going home shopping.
- Pre-approved buyers are seen as serious buyers
Once you are pre-approved for a mortgage, you have proof that you are a serious buyer; the pre-approval will add clout to your offer and place you in a higher negotiating power over other bidders that may not be pre-approved for a mortgage.
In cases where the seller is eager to sell, there are chances that the seller will accept your offer over other competing bidders because the pre-approval proves you are financially capable of securing the mortgage financing.
- Accurately find out how much you can afford
Getting mortgage pre-approved before you go house hunting allows you to know exactly how much house you can afford, which means you won’t waste time looking at homes outside your budget range. This narrows down your options, allowing you to focus on the goal, and it makes the home-hunting process much more efficient for you.
- Protect yourself against interest rates increases during the home buying process
When people buy a home and then go get a mortgage, they tend to accept whatever option is provided to them without asking many questions. Why? Because priorities change and sometimes that change in priorities means you end up getting a bad deal.
However, when you are pre-approved, the mortgage rate is secure and it will not change even if interest rates rise for everyone else; the best part is once you find your dream home, you are not obligated to sign with the lender that gave you the pre-approval. It’s a win-win.
Consider Ben and Carrie’s story.
Ben and Carrie found out the hard way, the value of getting a mortgage pre-approval before starting the home search.
As with many home buyers today, Ben and Carrie thought they had impeccable finances and did not need a mortgage pre-approval; so they decided to jump in the house-hunting process right away. After their offer to purchase a home was accepted, Ben and Carrie applied for a mortgage with their local lender.
Unfortunately, Ben and Carrie discovered that their finances were not impeccable after all. Ben had gone from being a salaried employee to self-employed; the lender needed at least two years of self-employment income which Ben did not have.
And, Carrie had changed jobs a month ago, which meant she was under her probation period. The lender needed assurance that Carrie’s job would continue long term but the probation period added to a higher risk of Carrie losing her job.
Needless to say, Ben and Carrie’s mortgage application was denied. They had the option to go to a B-rated lender but would need to pay a significantly higher interest rate.
Should you get mortgage pre-qualified or mortgage pre-approved? What’s the difference?
The reason for getting mortgage pre-qualified is to give you an idea of the amount of mortgage amount you can afford, whereas a mortgage pre-approval takes a step further and gives you a solid estimate of both what mortgage amount you can afford and be approved for.
You can think of a pre-approval as a test before the final exam; the lender will confirm the information you provide such as your income, savings, your credit score, your debts, and they will review your credit file in detail. If you pass the test, chances are you will pass the final exam.
The mortgage pre-qualification is more like a quiz, the process is a lot quicker and easier. You can do it by phone, by email, or online; the lender will ask for basic information such as the following:
- What is your annual income?
- Are you employed or self-employed?
- How much down payment do you have?
- What debts do you have?
- What’s your credit score?
However, the lender will not confirm the information that you provide because getting pre-qualified is supposed to give you an idea of what you can afford, vs. weighing in your chances of being approved for that amount.
So, is getting pre-qualified or pre-approved better?
Getting pre-qualified for a mortgage is good, but getting pre-approved is better. Sellers choose buyers who have a mortgage pre-approval letter over buyers who haven’t taken the time to find out if they can be approved for the mortgage.
Working with a Mortgage Broker
There are two ways you can apply for a mortgage:
- You can hire a mortgage broker or
- You can apply directly with the lender
If you hire a mortgage broker, he or she will research the market and compare various lenders before recommending the best option for you. They will make a process a lot less stressful and communicate with the lender on your behalf.
How to choose your mortgage broker?
The best way to find a good mortgage broker is to ask a friend or family member for a referral, but also check online and search for the most active mortgage brokers in your area and read reviews from their previous clients.
Especially if you have a complex application, make sure you favor experience above all else. Experienced mortgage brokers have established relationships with lenders, underwriters, and processors which will go a long way for moving things along.
They would be able to expeditiously deal with a given situation, and explain questions the lender may have. But be sure to interview at least three mortgage agents; ask them questions so you can determine their style, experience, expertise, and whether you want to hire them.
Interview questions to ask a mortgage broker
- How will you make sure I get the best rate?
- How many mortgages do you close in a year?
- Are you a licensed mortgage broker?
- How many years of experience do you have?
- What is your typical type of clients?
- Do you charge any fees or do you get paid by the lender?
- How many lenders do you work with?
- Which lenders do you work with?
Now, when it comes to choosing the lender, you will want to pay particular attention at the interest rate, and what additional fees the lender will charge.
Documents you will need for the mortgage application
The lender’s goal is to determine if you, as the borrower, can repay the mortgage. Thus, they will request you to provide documentation that proves the accuracy of the information you disclosed on the application such as your assets, debts, income, and credit history.
The exact documents you need to provide to the lender will vary based on your particular situation; however, here is a list of the main documents that will likely be required:
- Two pieces of photo identification
- Residential history for the past 3 years.
- Authorization for the lender to pull and review your credit report
- Proof of employment (last two pay stubs and letter of employment)
- T4 or W2 showing your annual income
- Notice of assessment for tax returns (for self-employed only)
Savings and debts
- Proof that you can pay the down payment and closing costs (bank statements 90 days)
- Information about your assets such as car, investments, or other properties you own
- Information about your debts (credit card statements, loan statements, etc.)
Being organized with the documents that lenders will require can go a long way. Download the below Mortgage Document Checklist to get a jump start on your application process by learning what documents you will need to submit to the lender.
Qualify for a Mortgage
To qualify for a mortgage you will need to prove to the lender that you can afford to pay back the loan. To determine that, lenders will use two main affordability ratios; the gross debt ratio (GDS) and the total debt ratio (TDS).
The process will start by finding out if you can afford to pay the mortgage and housing costs.
This is done by using the GDS ratio which states your monthly housing costs should not be higher than 32% of your gross income.
Housing costs include the following:
- Mortgage payment (principal + interest)
- Property taxes
- Utility costs
- 50% of condominium fee (if any)
The second step is to look at your total debt load. This is important because if you have high debt obligations it means you will have less money available to pay the mortgage.
To determine an acceptable level of debt load, lenders will use the TDS ratio. The TDS ratio states your total debt should not be higher than 43%. This includes your monthly housing costs, plus all of your monthly debt obligations, including the following:
- Housing costs
- Car loan payments
- Personal loans
- Credit card payments
- Child or spousal support
- Any other debt payment
For example, imagen your income is $45,000 per year and your spouse or co-applicant also has an annual salary of $45,000. So your combined family income is $90,000 per year.
Step 1: Calculate your family monthly income ($90,000 / 12) $7,500
Step 2: Calculate your home affordability by using the GDS Ratio
Multiply your monthly income by 32% ($7,500 * 0.32) $2,400
Step 3: Calculate your maximum allowed debt load using the TDS ratio
Multiply your monthly income by 43% ($7,500 * 0.43) $3,225
That means that with a combined family income of $90,000, the maximum allowed housing costs (including the mortgage payment) is $2,400 per month; and the total allowed payments to cover total debt is $3,225 including housing costs, which means there would be $825 to cover payments like a car loan, credit cards, personal loans, etc.
I encourage you to take your gross monthly income and multiply it by 32%; that will be your maximum allowed housing costs (including the mortgage payment). Then multiply your gross monthly income by 43%; that will be the maximum allowed debt monthly debt payments (including housing costs). The difference between the two is the maximum you can spend on paying off debt that excludes housing costs.
If you find that the amounts you get using these affordability ratios are too low you should consider doing the following:
- Buy a property in a lower price range
- Increase the amount of your down payment
- Pay off outstanding debt before applying for the mortgage loan
Questions to ask your lender or broker when getting pre-approved
You should ask the following questions when getting a mortgage pre-approval.
- Will you reduce my rate if interest rates drop while I am pre-approved?
- How long do you guarantee the pre-approval for?
- Can the pre-approval be extended if I don’t find a property by the expiry date?
Negotiate a better mortgage rate and better terms
Most homebuyers simply accept whatever option their lender offers, but the smart ones negotiate for things such as:
- a better interest rate
- no annual fees
- the term
- the amortization period
- If the mortgage is open or closed
- Option if you sell your property before the end of the term
The key to being able to successfully negotiate a better interest rate or better terms is to shop around. You have to check with more than one lender and try to find out what their best offers are.
Am I obligated to sign with the lender that gave me my mortgage pre-approval?
You are not obligated to sign with the lender that gave you a pre-approval; in fact, you should use that pre-approval as a basis to shop around and see what other lenders are offering before committing to one lender.
What if a lender refuses to approve my mortgage even though I am pre-approved?
There are two reasons a lender could refuse to approve your loan even if you are pre-approved.
- The property you bought is overvalued
- Something changed from what you disclosed on the mortgage application
Before extending a mortgage loan, lenders do their due diligence to determine if the property you are buying meets their standards and if the purchase price is close to or below the market value of a similar property. The lender is like your partner on this transaction, so they will take steps to verify the property is a good investment.
Changes after the mortgage application
Many people make this mistake; they get mortgage pre-approved and then during the home-buying process they go buy a new vehicle, book next trip to Europe, start buying furniture and charge it to their credit card or even change jobs to be closer to the new home.
Guess what? If your debt load changes, or if you change jobs, this means the information you disclosed on the mortgage application is now irrelevant. So the lender could say, “no loan”.
What are your options if the lender refuses to approve the mortgage after the pre-approval?
If the lender refuses to approve the loan, ask their reasons for the denial and ask them what options are available to you.
Some of your options may include:
- Applying with a different lender
- Pay off some debt to improve your debt to income ratio
- Applying for a lower mortgage amount
- Adding a co-signer to the mortgage application
- Increasing your down payment
How to increase your chances of being approved for a mortgage
These are the elements that determine whether or not you receive a mortgage approval:
- Your credit score
- The amount of your down payment
- Your total debt to income ratio
- The purchase price is at or below the market value
Excluding element number four above, the most important element is your credit score because it shows the type of borrower you are.
For instance, if you have a down payment of 30%, but a credit score of 600, you don’t get approved for a mortgage. However, if you have a credit score of 750 and just 5% down payment, any lender is likely to give you a loan.
So start building a great credit score today. You will still need at least a 5% down payment and keep your total debt to income ratio below 43%.
It’s a balancing act. If your application is weak in one area like a low credit score, you have to be able to compensate in other areas such as a higher down payment of a smaller house with a lower mortgage.
Complete a Home Buyer’s Online Course
Knowledge is power! To succeed in the home buying process you’ll need to know what to expect at every step of the way. You should check out our Home Buyer’s Online Course.
This is an interactive course designed in an easy to understand format; you will learn the eight steps you will need to take to achieve successful homeownership.