What determines a mortgage preapproval?

Calling all first time home buyers!  The preapproval for a mortgage loan is as important as finding the right mortgage lender.  When you understand how the preapproval process works, you’ll be better prepared to provide full documentation for your mortgage approval and increase your maximum loan amount. 

Verification Process 

Not to be mistaken for a prequalification, a preapproval will have a lender verify employment status, gross salary, debt to current income ratios, credit rating, outstanding credit balances and more.  Compared to a prequalfication, it provides a far more robust and accurate estimate of the home buyer’s ability to pay a mortgage, and will give an estimate of how much money a borrower may receive.  According to Bankrate.com, a lender will want to see a stable job history, including recent pay stubs, 2 or 3 years of tax returns and a decent FICO credit rating.

Credit Score

Checking your FICO score is a requirement of the preapproval process.  This FICO score is reported from three sources, Transunion, Experien, and Equifax.  Greg Meyer, from Meriwest Credit Union notes, “FICO takes several important financial factors into account. The two most critical factors are the borrower’s payments and the balances they maintain. These items make up 65 percent of the score; 35 percent for the payment history and 30 percent for the balance ratio. That’s why a late payment has such a serious effect on our score.” Knowing that a low FICO score can impact your loan amount is a serious wake up call, so give yourself extra time to preview it before applying for a loan.  Clear up any mistakes that appear on your credit history and monitor it regularly to ensure accuracy.

Debt to Income Ratios

The amount of money you have relative to the amount of debt you carry are important factors as well. “Lenders look at this ratio when they are trying to decide whether to lend you money or extend credit,” according to BankRate.com.  Mortgage lenders use two variations of debt to income ratios to help them approve a set amount for a buyer. The front end estimate, also called a housing expense ratio, shows how much gross income would go for a housing payment. This number is usually about 28 percent of gross income. Secondly, the back end estimate, or total debt to income ratio, is at 36 percent of a person’s total debt load.  This ratio includes payments for student loans, car loans, credit card payments and other mortgages and should not exceed 36 percent of gross estimated salary.  If the debt load is higher than this, a lender will want the borrower to decrease debt load.

Improve a Mortgage Preapproval

You can improve your back end ratio by paying down debt or increasing your down payment amount to bring to closing.  Also, you can improve your front end ratio by adding income from a second job.  In addition, showing a consistent history of making debt service payments on time will also give the lender increased confidence that you’ll be a responsible borrower.  Finally, keep in mind that a major change, such as a job loss or late payment on your credit report, can negatively affect your ability to get a loan and should be avoided during the mortgage process.

Jennifer@ElginFoxValley.com, E-Pro Realtor

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