Your Guide to Home Loan Pre-Approval
Getting the funds to buy a new home is hard. From going to lenders and brokers to checking credit scores and gathering documentation, things can get sticky fast. That’s why you want an advantage- something to put you one step ahead. But what can you do when there’s so much uncertainty involved?
If you’re looking for a mortgage, one of the best steps you can take is getting pre-approved. A home loan pre-approval gives you a foot in the door. It does this by letting lenders know how financially sound you are.
In this article, we’ll look at a few steps you can take toward getting pre-approved for a loan. We’ll also explain what these steps mean and how you can do them. Because, after all, some might not be familiar with the process of, say, checking a credit score.
So, without further ado, let’s dive right in.
What is Pre-Approval?
Loan pre-approval is essentially getting an offer given to you before actually taking out a loan. With pre-approval from a bank, you win options. You’ll know what terms you can get beforehand and be able to find the best deal.
On the banks’ side, it helps them get to know you. With the information they gather during the pre-approval process, they can make important decisions about your terms. They may decide to offer you a more lenient contract or a better deal.
With pre-approval, you get a foot in the door, knowing exactly what you can qualify for. Sure, you can look up a bank’s offers to other people or their average interest rates. But until you’re pre-approved, you can’t know exactly what they’d be giving you.
Calculate your DTI Ratio
When you’re looking for pre-approval, it’s good to get an idea of where your finances are. To do this, you may want to calculate your DTI ratio. DTI stands for Debt-to-Income, and it represents the portion of your income, as a percentage, that you use to pay off debt.
Whether you’re looking at student loans, car loans, or credit card debt, all of it will be factored into your DTI. So, if you’ve got an annual income of $50,000 and monthly debt payments totaling $1000, you’ll be looking at a DTI of 25%.
There are tons of DTI calculators out there, which you can use for free. For this article’s example, we used the DTI calculator. But feel free to look around if you want to itemize your debts and gain a more complete picture of your DTI.
Many sites will claim that a DTI ratio of 50% is a good place to start. Banks will see that you have some financial wiggle room and be more convinced that you can swing the extra expense.
We, however, would try to play it safe. In this day and age, it’s so hard to escape debt. But you want to get excellent offers on a mortgage. Thus, it would benefit you to do anything in your power to get your DTI down.
We recommend going into the process with a DTI of 37% or below. This will signal how financially competent you are and work as a great way to get lenders’ attention. Cut your expenses, pay up on your loans, and get that DTI down to a manageable range.
So, why do you need your DTI? Won’t banks be able to tell by your debt and income how financially stable you are?
Well, for one, accurately calculating your DTI neatly packages a significant portion of your financial health information. It’s like taking your loans and income and tying them up in a neat little bow. Banks can easily use this information whether or not you’re eligible for pre-approval. It will also show that you’re competent and prepared for the process.
As for the banks, they use DTI to determine whether or not you have the financial stability to pay your interest. If, for example, 80% of your income is going towards debts, you won’t have room to take on more. It also gives them a little bit of breathing room, letting them know that if interest rates increase, you’ll be good for your money.
And lastly, your DTI should also serve as a tool for you. If your DTI is too high, you should perhaps reconsider buying a home on loan. Take some time to work out your finances and chop some of that debt down. Living in a rented place isn’t so bad, especially if you can pay your expenses and work on clearing debt.
Work Out Your Credit
This should really be done long before you start the pre-approval process. Working out your credit is an integral step to getting pre-approved for a loan. Like with anything- from buying a car to renting an apartment- lenders use your credit to tell just how dependable you are.
There are many sites where you can check your credit. Equifax is used to store credit information in Australia. If you want a copy of your credit history you can call them direct. If you find a better one, feel free to use it. Just make sure not to get one that will fine you or lower your credit score.
If your credit is low, try looking up a few ways to bring it up. You can do this by, of course, paying bills on time and making sure you’re up to date on credit card payments. However, there are a few more finagle-y ways to add some points here and there.
One method, which is widely used as a sort of folk remedy to bad credit, is the grocery method. This method consists of buying cheap loads of groceries every week with your credit card. After that, you pay off the bill with the money you saved not buying groceries.
With this method, you can gradually drive your credit score up- bit by bit. Pair this with good budgeting and on-time payments of other bills like rent, and you’ll be in good shape in no time.
You can also request copies of your credit history- transactions and payments made to your creditors. With these, you can dispute errors in your credit and work to pay off unsettled debts. As these errors and issues disappear, your score will slowly rise. Make sure to resolve all of these issues before applying for a loan or starting the pre-approval process.
If you’re having trouble making sense of your credit score, just use this rule of thumb. Anywhere below 630 is not high enough- you’re going to want to get yourself up to about 750 before entering the process of loan preapproval. This will qualify you for the best terms and values on loans.
So, why do lenders love to look at your credit when you’re looking for a loan?
When you go into debt, you’re taking someone else’s money in exchange for a promise. You promise to use it for what you say you’re using it for, eventually paying it back and then some. Your interest is how banks make money giving out loans.
When you have a low credit score, banks know that you’re not good on your promises. They take a low credit score to mean that you won’t pay up. Thus, they can’t make a profit and won’t want to lend you any money. It’s just economics.
So, for while fixing your DTI showed banks that you have wiggle room, improving your credit will help you in other ways. It will show banks that you’re a dependable lendee and that you’ve got ways of paying back debts. Combining strong figures in these two categories will make you a viable candidate for pre-approval.
Get Your Documents Together
Throughout the pre-approval process, you’ll need almost every document under the sun. It’s good to go big, getting every personal financial document you can think of in one place. Here’s a checklist of what you might need. You can download this checklist (Available in PDF) from the Westpac Bank.
Tax returns (two years back)
Tax returns show banks what your income has been like over the last two years or so. They also let banks know that you pay your taxes and that you won’t be under threat from the IRS. This would throw a wrench in the system.
Bank statements and pay stubs
Banks will want to see what your spending habits are. This is to determine how smart you are with your money. For pay stubs, you’ll want to go back a month or more. Bank statements are a little more extensive, and you’ll want to get about 2 months’ worth of them.
If you have one, get your driver’s license. If not, a passport will also work. Any current document that can prove you’re a legal citizen. Lenders use these to make sure they’re lending to who they think they’re lending to.
Special forms for self-employed people
These forms will let the bank know precisely how you’re making your money. They want to get to know you pretty intimately. Because of this, having an employer’s W-2 is an advantage. However, if you’re self-employed, you can still offer proof of your income. Get your K-1 or form 1065 together to make sure you’ve got the information lenders need.
Income tax returns
These will also help banks get to know your finances.
Gather any documents with information on your assets. Things like retirement, bonds, stocks, and other financial assets.
Why All the Documentation?
Reding this long list, you may be wondering why lenders need so much documentation. You might be wondering if it’s even worth your while to get all of that together. To prove our point, we’ve included an explanation as to why you need your documents together:
When you go about looking for a pre-approval, many factors can affect your viability. For example, you might not be a very good borrower. You may also be a wild spender. To make sure you’re not any of these, lenders need a good look at your finances.
By providing financial documentation, you give them the overview they need to make sure you’re a candidate. Getting the correct information all at once will make you seem that much better.
Also, there’s the potential for fraud that they have to worry about. If you’re not who you say you are, a bank could get in some pretty hot water, legally or financially. Therefore, they have to know exactly who you are and where you’re from.
Knowing your assets, too, will help banks make a decision. This will let them know how much overhead you’ve got to keep making payments. It will also let them know your overall financial value. With all these aspects at their disposal, lenders are uniquely disposed to offer loans.
Make Sure to Contact Many Lenders
While you may like the sound of your first offer, you would be smart to contact a variety of lenders. This is to make sure there aren’t any other deals you might be missing out on.
Some lenders may not mesh well with you needs. These lenders are very by-the-book and strict with their application process. Others may be able to work with you to get you in better shape to get pre-approved. It’s all about finding the right lender with the right policies.
You may not think that there’s a lot of gain to be had in comparing lenders all day, but statistics say otherwise. On average, buyers will save more than $400 per year just by comparing the terms of different deals. When you’re dealing with potential charges and down payments, you’ll need all the money you can get.
By the end of your mortgage, you could have saved up enough money to build a garden or a small addition to your home- if that’s your thing. In the world of financing, it’s best to play it safe and do your homework. You could be missing out on thousands of dollars if you don’t.
Try Getting Pre-Qualified
If you’re wary about how many documents you have to provide, you might try pre-qualification. Pre-qualification is like pre-approval, but you don’t need as much paperwork.
Your finances are less looked into with pre-qualification, and your lender won’t look over your credit. This may sound like a good deal, but it does have one obvious advantage.
Without your credit, your lender won’t know how trustworthy you are when you take out a loan. Because of this, you won’t be receiving anything but estimates on loan terms, which are subject to change if a lender doesn’t like what it finds out about you.
Pre-qualification can help you get an initial feel for the loan market before you do any substantial preparation. With the knowledge you gain during the pre-qualification process, you can make educated decisions about what to do about your finances and how to proceed.
Get in Touch With a Broker
If you need help on your pre-approval process or think you could get better deals, get in touch with a broker. Brokers are trained professionals who help people get loans every day. They’ll help you gather your documentation, get your finances straightened out, and get on track to an outstanding mortgage.
Make sure to look into your broker’s history with clients before committing to anything. Simply ask to speak to a client before you hire the broker. If they don’t hook you up with a former client, they’ve probably got something to hide. Stay away from suspicious brokers and brokerages.
Also, make sure to check online for any reviews. When you’re looking for a broker, trust is key. Finding reviews online will help you to find out how a broker has treated people in the past and how they might treat you.
Keep in mind that brokers are people too, and there are good ones and bad ones. Hiring an overly profit-motivated broker will lead to conflicts of interest, and you may find yourself wishing you had never hired one at all.
Also, keep in mind that brokers often charge a pretty hefty fee. If your pre-approved loan does happen to go through, you’re responsible for that fee. Their charges are usually taken as a percentage of the loan secured. So, if you got a $300,000 loan, you may end up having to pay a $3000 fee to your broker- or more.
Trust in brokers is falling, however. The 2008 financial crisis put brokers’ activities under scrutiny, and many people no longer trust them. In addition, some lenders have found out that loans negotiated by brokers are more likely to default. For this reason, getting pre-approved for a loan can actually be harder with a broker.
In the end, you’ll just have to make an educated decision based on your finances and dedication to the process.
All in All
All in all, there are many steps to getting pre-approved for a loan. Gathering financial information should be your first action. After that, contacting a broker may help. If you don’t want to do all of this, try getting pre-qualified instead. Keep in mind that this doesn’t have some of the advantages of pre-approval.