If you’re serious about buying a home in 2012, one of the first questions to ask yourself is how much you can afford. For most people, getting a mortgage will be how they pay for the home over time, so naturally you’ll want to know what amount an affordable monthly mortgage payment will be. Most home sellers want to deal with potential buyers who are serious about buying a home and who can afford to pay for the house that they buy. They LOVE cash buyers who don’t make an offer that’s contingent on selling their existing home, and/or getting a mortgage approved. However, if you intend to submit an offer that’s contingent on your getting a mortgage, a home seller is almost always going to ask whether you’re pre-approved (not “pre-qualified”) for a mortgage on the amount you want to borrow. They don’t want to waste their time considering an offer if there’s a good chance that the mortgage will fall through.
Before we discuss the difference between being “pre-qualified” and “pre-approved”, let’s step back a bit and look at what a mortgage is. Most monthly mortgage payments will cover (1) the amount of interest you’re paying for your loan, (2) a payment of a portion of the principal, i.e., the amount of money you borrowed, and (3) an escrow payment to cover taxes and possibly insurance.
Let’s say that you want to borrow $200,000 so you can buy a house. With mortgage interest rates at or near all-time lows, monthly mortgage payments are going to be significantly lower than they would have been 5 years ago. There are many web sites that offer a simple monthly mortgage estimate calculator, but be careful- most of these only account for the mortgage’s principal and interest, and don’t include things like taxes. A web site that I recommend is http://www.bankrate.com/calculators/mortgages/new-house-calculator.aspx because it’s more thorough, and takes into account both your income and some of your other common expenses. It lets you decide whether you want a 30-year fixed mortgage, a 15-year fixed mortgage, etc. As you know, your monthly payments will be higher on a 15-year mortgage, but you’ll pay a LOT less interest over the course of the loan.
Once you have a rough idea of what amount of mortgage you think you can afford, it’s time for a reality check. What matters isn’t what you think you can pay, it’s what a lender is willing to loan to you. Lenders are a lot fussier now than they were 5 years ago, so they’re going to be conservative when they lend money because they want to make sure you’ll be able to repay it. When you go to a mortgage professional, he/she can either “pre-qualify” you or “pre-approve” you, and it’s important that you know the difference.
When you ask to be “pre-qualified”, the mortgage professional will ask you for some basic information such as your income, your credit report, your current debts, etc. Based on his/her review and experience, the mortgage lender will give you a free ESTIMATE of the size of the mortgage he/she feels you can reasonably repay. It’s a quick review and not a commitment to lend you that amount of money. Think of it as something akin to the estimate you’d get by using the bankrate.com web site above. If you’re serious about buying a home, my recommendation is to get pre-approved instead of pre-qualified.
When you ask to be pre-approved, you’re actually applying for a mortgage, and you should expect to pay a mortgage application fee. You don’t need to know the address of any specific house, you’re just asking the mortgage lender to commit to give you a mortgage loan for up to a certain amount when you find the house that’s right for you. It’s easy to reduce the amount of money that you borrow, but if you need to borrow more than you originally asked for, you basically have to go through the entire process all over again. Once you find “the right house”, the mortgage lender is going to insist that the house is worth more than the amount you’re borrowing, so that contingency will be part of any pre-approval letter he/she gives you. Obtaining a pre-approval often takes 4 to 6 weeks, because the lending institution is going to do a very thorough check of your financial situation. However, getting a mortgage pre-approval will certainly speed up the time between the date when you sign a home purchase agreement with a seller and the date when you can actually close on the transaction.
Although many people would say that we’re in a “buyer’s market” for real estate, the fact is that many homes do get listed at a price close to fair market value. Homes such as those often appeal to more than one savvy buyer, so if you’re pre-approved and the other buyer is only pre-qualified, the seller is going to feel that your offer is more serious than the other person’s offer.
Don’t forget: being “pre-qualified” is NOT the same as being “pre-approved”.