Laura answers a listener's question about how much to spend on a home and the benefits of getting a mortgage preapproval.
Laura answers a listener's question about how much to spend on a home and the benefits of getting a mortgage preapproval.
Transcript: https://money-girl.simplecast.com/episodes/how-do-i-get-preapproved-for-a-mortgage/transcript
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Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! Pat sent in today’s question, which is:
“I just relocated to a suburb of Tampa for a new job and signed a six-month lease. I have family in the area and would like to eventually buy a home and stay here for the foreseeable future. But I’m unsure how much I can afford and how the mortgage process works. How far in advance should I contact a lender and get pre-approved for a mortgage?”
Pat, thank you for this question! Congratulations on your new job and finding a place where you want to put down some roots. Buying a home is a big commitment, and it’s wise to take your time and get fully prepared before starting your search.
This post will discuss the benefits of getting a mortgage preapproval and what to expect when buying a home. Whether you’re a first-timer or an experienced homeowner, you’ll learn tips to cut the cost of buying real estate and expensive mistakes to avoid.
Welcome back to episode 943 of Money Girl–I appreciate you downloading the show! I'm Laura Adams, an award-winning author, on-camera spokesperson, female money speaker, and founder of The Money Stack, a Substack newsletter.
You can learn more, ask questions, and sign up for the Money Stack at LauraDAdams.com. Also, reach out if your organization could benefit from having a remote or in-person speaker take your financial education and motivation to the next level.
What is a mortgage preapproval?
Getting a mortgage preapproval is the first step in forming a relationship with a lender and securing financing for a home. A preapproval is when a lender or mortgage broker reviews your finances to determine if you qualify for a mortgage and how much you might be approved for.
A preapproval also helps you identify any weaknesses in your finances, such as a low credit score or insufficient down payment, that could result in a less favorable mortgage offer. In that case, postponing homeownership until your finances improve may be a wise decision.
A lender typically reviews your income, assets, debts, and credit before issuing a preapproval letter. It includes the highest home purchase price and loan amount they’re willing to give you. It will specify if financing is contingent upon the sale of another piece of real estate, such as your current home.
A mortgage preapproval typically comes with an expiration date of 60 or 90 days. However, if you don’t find anything or make an offer on a property that gets accepted before the expiration, you can get another preapproval.
Having a mortgage preapproval shows a real estate agent or seller that a lending professional has reviewed your finances. It shows that you’re a serious buyer and are looking at homes within the right price range for your budget.
Buyers with a mortgage preapproval may have an advantage when there’s another buyer without one who’s bidding on the same property as you. A buyer with a preapproval may seem less risky to a seller because financing isn’t likely to fall through, wasting precious time.
But you should never feel pressured to borrow the full amount that a lender says you can. Remember that before a lender knows the address of a property you’re considering, they won’t know various expenses like property taxes, insurance, and any condo or homeowners association (HOA) dues.
In specific communities with amenities like a tennis club, golf course, fitness room, pool, boat dock, or beach access, you may have a mandatory membership fee in addition to HOA dues. So, be sure to factor in all potential costs when deciding if you can genuinely afford a home.
My last home cost about half of what my lender’s preapproval was. I think it’s more important to decide the maximum you want to pay per month, inclusive of all homeownership costs, than to fixate on a top purchase price that a lender says you can afford.
READ ALSO: Know your score and improve your credit
How do you get a mortgage preapproval?
A mortgage preapproval begins by contacting a lender or mortgage broker online or at a local institution. You can work with a bank or credit union where you’re already a customer or start with a new company.
If you’re working with a good real estate agent, they should have some mortgage recommendations. I recommend getting more than one preapproval and comparing loan rates, terms, and fees to get the best deal.
I typically work with a mortgage broker who has a deep understanding of the local housing market. Not only can a broker shop your application with different lenders, but they can also estimate your closing costs more accurately. Working with a broker allowed me to save half a percentage point in interest on my last home purchase. Over time, that savings can really can add up. So, be sure to compare a couple of mortgage offers before settling on one.
Once you authorize a lender or broker to begin the preapproval process, they’ll get your permission to review your credit and ask you to submit or upload the following documents to prove your:
Pat asked about the timing for getting a mortgage preapproval. Since it’s typically good for just 60 to 90 days, wait until you’re ready to start home shopping before requesting a preapproval.
Once you make a purchase offer that a seller accepts, consider what’s happening with mortgage rates. If they’re trending up or fluctuating, as they have been this year, it’s best to lock in your rate quickly so you pay as little as possible. A lender may allow you to keep a rate for 30 to 60 days while you work through contingencies, such as inspections, and complete the deal.
When I bought my home, interest rates were moving down, so I wasn’t in any hurry to lock in a rate. I was able to keep an eye on rates and wait until they weren’t likely to decrease further before my lender needed to lock it down.
How much mortgage preapproval will you get?
One of the reasons I recommend getting more than one mortgage preapproval is that every lender evaluates you differently. For instance, some lenders may require a higher credit score, such as 760 or above, to qualify for the lowest interest rate or a larger loan, while others may accept lower scores.
Your monthly debts, such as auto loans, student loans, and minimum credit card payments, are compared to your gross monthly income, resulting in a debt-to-income (DTI) ratio. The lower your DTI, the better for a potential mortgage approval. Mortgage lenders prefer a DTI of 36% or lower for conventional loans, but some are more flexible than others.
Some loans with government backing, such as from the Federal Housing Administration (FHA) and Veterans Administration (VA), may allow DTI ratios as high as 43%. In addition, you can have lower credit scores and pay as little as 3.5% down for those unconventional loans.
For conventional loans, making a larger down payment, such as at least 20% of a home’s purchase price, can help you get approved for a larger loan amount and lower interest rate. Additionally, it prevents you from having to pay an extra monthly fee, called private mortgage insurance (PMI). So, I always recommend putting down at least 20% when possible–but paying as little as 5% may be an option, depending on your lender.
Lenders are required to cancel PMI when you pay down your loan balance to 78% of the property’s original value or you reach the midpoint of your amortization schedule, whichever comes first. You can also request PMI cancellation when the loan balance reaches 80% of the original value if you’re current on your mortgage payments.
In general, you also must have enough cash to pay typical closing costs. They usually include fees for your lender, closing agent or attorney, title insurance, deed recording, appraisal, inspections, and other settlement costs. In general, they could be from 3% to 5% of your home’s purchase price.
It may be possible to roll some home closing costs into your mortgage or negotiate for a seller to pay some of them. However, it’s better not to finance them or to save more than needed and have excess cash after buying a home.
LISTEN ALSO: Should I pay down my mortgage early to eliminate PMI?
What is a mortgage prequalification?
If you’re just exploring the option of homeownership, consider getting a mortgage prequalification, instead of a preapproval. While they sound similar, they’re totally different in the mortgage world.
A mortgage prequalification is a quicker assessment of your finances, so you get a rough estimate of what you can afford. You self-report financial information, instead of going through a formal underwriting process where a lender verifies and analyzes your income, debt, savings, and credit.
If you get a mortgage prequalification, be sure not to make any significant financial decisions or changes. For instance, if you take out a car loan or open new credit cards, that could affect your DIT and ability to get a mortgage preapproval later on. Likewise, changes to your income or financial situation after getting a preapproval could result in your mortgage application getting denied.
How much mortgage can you afford?
Getting back to Pat’s question about how much home you can afford, it depends on your financial situation and goals. Many people used to say that it’s better to be house rich and cash poor, believing that property will always appreciate.
But spending too much of your savings and monthly income on housing can leave you financially vulnerable and unable to build wealth for the future. It’s not uncommon for people to spend 30% of their income on housing. However, I think keeping your total housing costs under 20% is a better target that will give you more financial flexibility.
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That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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