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Getting pre-approved for a mortgage means that a lender has evaluated your particular citation and has determined that loaning you a specific amount of money to purchase a home is a low-risk loan and that you’re likely to pay back that loan in full and on time, with interest.
By going through the pre-approval process, you’ll know exactly what you can afford before going house hunting. Not only will it make the home-buying process easier, but it also keeps you from falling in love with properties that are out of your ballpark, saving you time and possible disappointment.
Also, you’ll be taken more seriously by real estate agents who will want to work with you when they see that you are committed to buying and are pre-qualified to finance a home.
And when you find a home you are interested in making a bid on, the seller will know that you’ve already got the backing from a bank or mortgage company. That can really help with your ability to negotiate!
Like everything else in life, getting pre-approved takes some effort. Luckily, most of it is done by the lender while you wait. Before a pre-approval is even considered, they’ll check several variables to get a better picture of your current situation. Financial stability is one such variable. Others include:
Whether you qualify will depend on their standards and requirements. Every lender is a little different. But if the lender gives a thumbs-up after reviewing the factors in the list above, they’ll provide an amount they’re willing to let you borrow for your house purchase.
Typically, lenders focus on the following three aspects to help them determine if you are eligible for pre-approval and, if so, what amount they will loan you.
Gross income
To determine how much of a monthly payment you can afford, mortgage lenders will analyze your debts and look at your gross income — not your net take-home pay. Gross income is defined as the sum of all wages, salaries, interest payments and other earnings — before taxes. Why is gross income used instead of net income? Because borrowers are more familiar with how much they make a year than how much they take home every month, especially if they’re paid weekly or bi-weekly.
Debt-to-Income (DTI) ratio
Your DTI is your gross income compared to how much debt you have. That formula will help determine a total monthly mortgage payment that they feel you can afford, including principal, interest and taxes. That figure should be no more than 28% of your gross monthly income. They then take that number and add in all your monthly debts like car loan payments, monthly credit-card minimums and student-loan bills. This new figure should be no more than 36% of your gross monthly income. A DTI on the high side means your debts may impact your ability to make your proposed monthly mortgage payments, and, unfortunately, you probably won’t get the loan (or you’ll have to fall back to a small amount to borrow.)
Credit score
Once gross income and DTI are figured out, lenders will look at your credit score. Even if you have a high DTI, all is not lost — a favorable credit score may increase your chances of getting pre-approved for a loan because it shows you can handle a higher amount of debt. Remember, every loan and lender has different credit score benchmarks, so if you don’t meet the requirements for one type of mortgage, you might meet those of another.
Once you’re pre-approved for a loan, you’ll know how much you’ll be able to comfortably pay every month. What you may not know is that you can actively influence that outcome.
Here are 4 ways you might be able to lower your monthly mortgage payment.
Improve your credit score
With a higher credit score, you increase your chances of being offered a lower interest rate — hence lower payments. To improve your credit score, follow these tips: do your best to pay every bill you get on time, pay off your debt, make payments more than the bare minimum and keep balances low on your credit card accounts. Lastly, closing unused accounts can negatively impact your credit score, so don’t do it until you’ve closed on your new house.
S-t-r-e-t-c-h the mortgage term
A mortgage term is the time you have to fully repay the loan. For most mortgages, terms are either 15, 20 or 30 years and if your payments are extended over a longer time, they’ll end up being lower. Extending the loan may increase how much interest you end up paying over the long haul, though, but it can reduce your DTI and help you get the loan approved in the first place.
Save up more for your down payment
Downpayments of 20% of the purchase price used to be commonplace, but these days loans are available to borrowers putting only 5%, and sometimes 0%! If you really want to lower your monthly mortgage payment, put down more cash than you originally planned to. The higher your down payment, the lower your monthly payment will be.
Say goodbye to PMI
When house prices were lower, it used to be the norm for first-time homebuyers to try to save for a 20% down payment. With people putting up less than that, lenders are taking a bigger risk that a borrower may default, and they take out private mortgage insurance, or PMI, to guard against that. Unfortunately, they don’t pay for the insurance; you do — it’s added to your monthly mortgage payment. But by putting 20% down — or by eventually getting to 20% equity through multiple monthly payments, you can get rid of PMI altogether, which will lower your monthly home loan payment.
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