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Why every home buyer needs a pre-approval before home shopping

Craig Berry
Craig BerryThe Mortgage Reports Contributor

In this article:

Before you shop for a home, unless you’re paying cash, mortgage pre-approval is your #1 home buying preparation tool.

  1. Pre-approval tells you what price range you can afford
  2. Realtors and sellers won’t take you seriously without it
  3. Your mortgage process will be smoother and faster

Those advantages should be enough to convince you. But 42 percent of homebuyers go shopping for a home without mortgage pre-approval.

Verify your new rate (Oct 21st, 2018)

John and Linda’s story

Suppose you ignore this advice and hit the virtual tours in a hot market. What if on day one you fall in love? That could be a problem because unless you’re paying cash, no one will take your offer. You might not even be allowed to view the property in person.

Just ask John and Linda, real home buyers who found out the hard way.

John and Linda jumped the gun and began their home pursuit by searching for properties online.

Related: How long does it take to get pre-approved for a mortgage?

Once they found a few homes they liked, the couple contacted a real estate agent about seeing the properties. The agent asked if they had a mortgage pre-approval letter. John and Linda assured their agent that their credit and finances were impeccable, everything was in order, and there would be no problems.

Shop for money, then shop for houses

Unfortunately, John and Linda were wrong. In fact, their offer never got off the ground because they couldn’t produce a pre-approval letter. In many of today’s hot sellers’ markets, a solid pre-approval letter is a must.

To add injury to insult, John and Linda discovered that their finances were not as “impeccable” as they’d believed.

Related: 5 steps to take before you make an offer on a home

John had recently made the switch from salaried employee to a self-employed business owner. That alone can make mortgage approval difficult because lenders almost always need to see at least two years of successful self-employment before they accept that income.

In addition, John, like many business owners, wrote off a sizable chunk of his gross (before tax) income — and that’s the income most mortgage programs use to determine what you can (or can’t) afford.

John and Linda were embarrassed and disheartened to find out that their purchasing power was only about 80 percent of what they’d expected. That’s why it’s smart to shop for money, then shop for houses.

Sellers are pickier than ever

It’s a hot market in just about every part of the country. This means that sellers can be pickier when choosing what offers they’re willing to accept.

Related: 10 reasons your home purchases didn’t go through

In a hot seller’s market, inventory tends to be scarce. Getting pre-approved gives you a leg-up on your competition. A mortgage pre-approval allows you to make an offer with confidence and shows that you’re a serious buyer with the means to purchase a seller’s home.

Many real estate agents won’t even allow homebuyers to tour their listing if the buyers don’t show up with a pre-approval letter from a reputable mortgage lender.

What is a pre-approval letter?

A mortgage pre-approval letter from a lender assures you, sellers and real estate agents that you have the ability to a complete the purchase of any home that meets the lender’s guidelines.

Mortgage pre-approval shows you what you can afford to spend and what your monthly payment will look like.

Mortgage pre-approval is not merely pre-qualification. Many lenders issue “pre-qualification” letters after asking you about your income, debts and assets, and perhaps checking your credit.

Related: Mortgage pre-qualifications are good (but pre-approvals are better)

While a pre-qualification letter is better than nothing (at least you put some thought into your prospective purchase), it can’t compete with an offer from a pre-approved buyer. To secure a mortgage pre-approval, you must complete a mortgage application and submit all required documents. These can include (but are not limited to):

  • Pay stubs and W-2s (typically two years)
  • Tax returns (typically two years if self-employed or you earn commissions or bonuses)
  • Bank, retirement and investment account statements (two to 12 months, depending on loan)
  • Financial statements (if self-employed)
  • Letters of explanation for credit blemishes
  • Divorce decrees, if you pay or receive spousal or child support

Often, one document might trigger a request for others. For instance, a bank statement showing 15 bounced checks in a single month might cause an underwriter to question your financial management skills. It’s best to resolve these glitches before home shopping.

You can get a pre-approval letter and shop for rates later

You don’t have to go with the lender from which you receive your pre-approval letter.

Get your pre-approval from any reputable lender, and get an accepted offer on a house.

From there, shop your mortgage to at least three, but potentially many more lenders. Get the best rate you can, as long as the lender can close on time.

Studies show that many homebuyers quit mortgage shopping after getting one quote. But a Stanford University study showed that failing to compare quotes from at least three or four mortgage lenders costs buyers on average over $2,500 in extra fees for a $200,000 loan.

Related: 4 types of mortgage companies (Which gives you the best deal?)

So, don’t let mortgage rate shopping deter you from getting a pre-approval letter first. After all, the best rate in the world will do you no good if you can’t buy the house.

Verify your new rate (Oct 21st, 2018)