The Home Buying Process, Part Three: Gotta Love Loan Applications

Before we start talking about loan applications, I have a confession to make: I took a lot of shortcuts in getting our mortgage loan. See, when I was a Realtor, I made a lot of connections — a lot of them — and even though it has now been a few years since I surrendered my license, many of the folks I worked with back then are still around. I even call them periodically when I need information that I can’t find for this website — so when I knew we were thinking about buying a house, I didn’t mess around.

I called this guy to help me with my mortgage. We’ll call him Bob (not his real name). Bob’s a loan officer at a reputable bank, and I simply phoned him up one day and did our pre-qualification over the phone. The difference between me and you, though, is I had already figured income to debt ratios, pulled credit reports and came generally armed with information Bob found credible. You can do all those things, too, but your banker probably won’t believe you — they’ll check it out for themselves.

The Difference Between a Pre-Qualification and a Pre-Approval

A pre-qualification, while good to have when shopping for a home, is not a pre-approval. This is important to know because there is one pretty major difference, and it happens to matter a heck of a lot. When you go look at houses and you want to be in a strong negotiating position, bother to get a pre-approval first. This is why:

It’s a loan promise. Unlike a pre-qualification that’s based on your beliefs about your income and your debt, a pre-approval is based on all your paperwork. The lender will pull a full credit report, look at your income documents, examine your debts and generally have a good picture of what they will and won’t do for you, loan-wise.

Your approval, of course, can turn into a denial if you make a huge mistake like maxing out your credit cards in the stressful time between signing a contract and the closing table. You can be denied even if you have a pre-approval if you don’t follow your lender’s instructions.

You’ll have all the facts. Your pre-approval will come with a maximum purchase cap, a breakdown of the anticipated payment for that loan, a list of the closing costs and down payment amounts you’ll have to bring and the type of loan you’ll be able to get. All that information is vital, for example, when you’re having to decide if you need a seller to make a particular repair, or if you can do it yourself.

In our case, since we were aiming low with a Conventional loan, we knew that as long as the price point was minimal, we could do a number of repairs. On the other hand, if you’re using an FHA loan, for example, certain items must be in good repair before you can close.

Sellers will know you’re serious. Of course, the most important reason to get pre-approved instead of pre-qualified, is to make your offer presentation look its best. Sellers don’t just consider the dollar amount or the bottom line (though that’s a really important factor) — they also want to know how difficult you are going to be to deal with.

In a multiple offer situation, the buyer who bothered to get a pre-approval is the buyer who has their act together and is ready to move as the situation requires it. A Seller may consider a lower offer from a buyer who looks like they’ll be fair and organized throughout the buying process.

The Loan Application Process

When you go to make the initial loan application, you’ll be asked to submit a pile of paperwork. It’s not a great first impression, I know. But if you do your paperwork up front, the rest of the process is pretty easy for you as a Buyer. For most loans, you’ll need the following documentation:

Your last pay stub. The bank needs to verify your current income. This is the best way to prove it, but if you’re self-employed it obviously won’t apply. A year-to-date profit and loss statement can help if you’re not conventionally employed.

Your last two years of tax returns. You need proof of current income, but the bank also wants to know that that income is stable. If your tax returns reflect a lot of careers changing or lengthy unemployment, it may cause a problem in the loan process, or at very least an adjustment to the gross income figure they use to calculate your debt to income ratio.

Your most recent bank statements. Although banks have always wanted to verify that you have funds to close tucked away somewhere, since the Patriot Act was signed into law in late 2001, they have been forced to really scrutinize that money. This is why it’s vital to keep your money in a bank if you want to buy a house — you’ve got to be able to establish a paper trail from the source to the account.

If you get regular paychecks, this is a no-brainer, but self-employed or people who are being gifted money need to pay strict attention to the time tables your bank will give you for aging money in your account to ensure you can close on time.

We had to document that our down payment came from my husband’s 401k, even though we declared it — paperwork!

Your most recent statement for any retirement accounts. Many types of retirement accounts can be used as your cash reserves for verification purposes. This is the easiest way to go about it, frankly. Although many loans don’t require much in the way of reserves, if you’re in a situation like we were, you’ll have to really prove you can cover.

We bought another house before we sold our old one, to simplify the sales process and to get the most money out of the old place — but that required that we have cash reserves for both the new and old houses. Thankfully, my husband has been stuffing money in his 401k since he started working, so it was no problem to verify that amount.

Any divorce decrees for you or your spouse from former marriages. If you’ve ever been divorced, keep that divorce decree! Your bank will need it to see it to document any alimony or child support you’re paying and to ensure that whatever comes up on your credit report is explainable as you explain it. For example, your wife may have been ordered to pay the joint credit card bills, but doesn’t pay on time — that can be compensated for if you can prove it’s not your responsibility anymore.

Other papers to prove eligibility. There are a number of other papers you may need, depending on your circumstances and your loan type. VA loans will require proof of eligibility, for example, and other loans may require that you prove your permanent status in America if you’re an immigrant or resident alien. The bank wants to know you’ll be there to pay the mortgage, after all.

After the Paperwork

One you’ve got all your initial paperwork submitted, your banker will attempt to see if his computer can automatically underwrite the loan. This essentially means that you’ve not got any major problems and the bank has approved your mortgage, provided you can follow instructions and not change your credit profile for the worst in the time it takes to close. Automatic underwriting saves a ton of time and effort — so you want to go in as gold as you can.

Even so, you may have to provide additional documentation, just like with a manually underwritten loan. Either way, a human will at least glance at your packet to ensure you’re really credit-worthy and not just a glitch in the system. While you’re busy getting your home inspection and negotiating repairs, your underwriter will be ordering title work and arranging your appraisal, as well as working their magic with your file.

Usually, this part is pretty invisible. This is the time when your income, assets and employment are verified and your credit is also re-checked. They’ll be watching carefully for you to slip up and max out your credit cards or take out a new credit line. This is crunch time, so don’t do that. I really mean it. That’s why I keep saying it over and over.

I had a client once who decided it was a good idea to open a store account at Target in the middle of what was one of the most grizzly loan approval processes I’ve ever been a part of. They also maxed the thing out — right away — and completely wrecked their credit score and debt to income ratio. There are few things that will hurt your credit as badly as carrying more than half the credit line of any given card as a balance. But these guys did it anyway.

And bless them, the underwriters and bankers worked their hardest to get the loan finished before that couple could finish off the financial apocalypse they started, but it just wasn’t to be. This is how I know you really can be denied, even with an approval. Everything’s got to be stable — your financial picture must be the same in the days and weeks leading up to closing as it was when you applied for the loan.

The Bottom Line: Approvals Are Just Another Beginning

Your loan approval isn’t the end, it’s the beginning. So don’t assume that you can do something squirrely like max out your Target card — okay? Keep your financial picture steady, don’t cause any blips on the FICO radar and don’t make any big purchases before you close. Hold on to that Lowe’s credit account application, but don’t pull the trigger until you’ve signed on the dotted line.

I know it can be tempting to go ahead and buy curtains and it can be hard to keep on top of meals and work during the buying process, but whatever you do, maintain a steady pace. Your underwriters will thank you, your banker will thank you and you’ll breathe a huge sigh of relief when you get to closing. One thing at a time, little grasshopper…one thing at a time.

Mortgage loan approvals are a test of your sanity, there is no doubt, but it’s only a few weeks. Stay strong. You can do it!

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