Has this ever happened to you? You are pre-qualified with a lender for a certain loan amount and spend the next few weeks with a Realtor searching neighborhoods until you find the perfect place and negotiate a contract. You are through the moon excited because it’s the right price in the right location. You tell your parents. You tell your friends. You tell your co-workers. You tell your book club members. You tell everyone you know that you’ve finally found your dream home and that you’ll be moving in a few weeks. Then, three weeks down the road, you get the call, “I’m sorry Mr. Smith, but we are unable to approve your loan request.” Your stomach sinks to the floor. Everything had seemed to be going along perfectly. You gave everything that was asked of you, time and again. What happened?
That experience can be both embarrassing and hurtful to you and your family. Whether you are a first-time homebuyer or a long time real estate investor, understanding and preparing for each step of the loan approval process can avoid delays due to missteps, miscalculations, misunderstandings, and unintentional misrepresentations. Too many times, buyers simply go off the estimations given with a pre-qualification and commit to a property only to learn later on that something about the initial data listed on their loan application was significantly different from verified data.
The process of mortgage approval is basic, but it consists of six steps. In the above scenario, you probably started with step three, skipped over steps four and five and then expected to land on step six. The first two steps are completed without the involvement of your lender and will require a significant investment of your time, attention to detail, and effort in making corrections where necessary. The remaining four will have you working closely with your lender.
Step 1: Credit Report
Knowing your credit profile is key in determining loan program eligibility. Get a copy of your credit report and dissect it looking for errors and confirming accuracy. You can obtain a free copy of your credit history annually at Annualcreditreport.com. While this is a good place to start, it doesn’t provide your FICO score that loan officers will need as a guide to prepare cost estimates and have discussions around loan program eligibility. Service providers such as Identity Guard provide you with access to your scores from all three credit repositories (TransUnion, Equifax and Experian) for a monthly fee and have options to help you monitor credit activity, prevent identity theft and model the impact of changes to your credit profile.
Step 2: Supporting Documentation
Gather all documentation as listed on the Comprehensive Mortgage Documentation Checklist.
Step 3: Pre-Qualification
Sometimes people use the words pre-qualification and pre-approval interchangeably, but as they apply to mortgage financing, they turn out to mean quite different things. In the pre-qualification phase, we take a look at your loan program options. You’ll likely have a discussion with a loan officer where you’ll share the amount of monies you have available for down payment and closing costs, your monthly income, recurring debts and offer an estimate of your credit score. Quick calculations are performed that suggest how much home you can afford and discussions are had over which loan programs you may be eligible. You’ll also learn what documentation is needed and have a general expectation of the timeline for when you should make formal application and the application fees that will be required.
While pre-qualification is an important step in the process, if all you have is a pre-qualification letter, you essentially don’t have a solid commitment to lend from a creditor. A creditor is the entity that funds your loan. It could be a bank, a nonbank mortgage company, or a private investor. Within each of these classifications, there are hundreds of entities providing different loan product options, adhering to different underwriting guidelines, lending on only certain types of housing, and pricing their loans based on assessed risk and desired profit margins. I use the term “loan officer” throughout for reader clarity, but you can make application directly with a representative of any of these creditors or you can engage with a mortgage broker who searches for a creditor that matches your specific needs.
Step 4: Pre-Approval
The US government has decided that a lender cannot “require” that you provide supporting documentation before it issues loan disclosures. That said, it doesn’t disallow a lender from collecting supporting documentation. This post isn’t about what a lender needs to do to stay compliant with government regulations. This post is about how you can successfully navigate the mortgage approval process. Bring your supporting documentation to your lender meeting so that you can have a meaningful conversation over program eligibility, identify areas of concern and list accurate data on your loan application. Gathering documentation is time-consuming. If you’re someone who struggles with organization, put your financial house in order right now in preparation of homeownership by following the instructions in Step 2.
Your lender will obtain a copy of your credit report using one of their vendors. Program eligibility is once again reviewed and pricing is re-calculated based on your now verified representative credit score. At this point, you may need to reconsider loan programs or down payment options if your credit score varies significantly from your initially estimated score. When you make loan application, you can only select one loan program for lender consideration.
With a program selected, the data on your loan application is run through an Automated Underwriting System (AUS). A lender will typically use Desktop Underwriter (DU) or Loan Prospector (LP) that are the proprietary underwriting systems for the government-sponsored entities (GSEs) Fannie Mae and Freddie Mac, respectively. Sometimes a lender will use their own proprietary AUS system to accommodate for their specific portfolio lending programs or additional overlays (restrictions) to GSE guidelines. Based on the initial AUS findings, the loan officer will receive a recommendation and a list of loan conditions.
While a pre-approval is significantly better than a pre-qualification because credit history is reviewed and a recommendation of approval is received, an underwriter (decision maker) has still not reviewed your supporting documentation. A pre-approval just sits with the loan officer until you receive and review loan disclosures and issue your Consent to Proceed with the loan application.
Step 5: Conditional Loan Commitment
You may be thinking that you don’t have to go through the trouble of a “formal” review of your loan application but you should because rarely is the income you disclose at application the qualifying income that a lender can actually use. Once consent is recorded and application fees are collected, only then is your loan file submitted to an underwriter for review. This process can take as little as two days or as long as four weeks, depending on lender turnaround times. Having submitted all necessary loan documentation, you should expect this initial conditional loan commitment to be issued subject only to acceptable appraisal, clear title and property insurance.
Now you can begin shopping for a home.
Step 6: Final Loan Commitment
With a purchase contract in hand, a lender then orders a property appraisal and a title request is sent to your selected settlement agent. When the appraisal comes in, you are given a copy and you will begin working with your insurance agent to secure adequate property insurance coverage and provide evidence of that coverage through a Certificate of Insurance.
When the lender receives all documentation complying with the preliminary loan conditions and the appraisal is in, the file goes back to the underwriter with the hopes that the documentation submitted complies with the requirements to satisfy loan conditions and a Final Loan Commitment is issued. The Final Loan Commitment will show that all preliminary funding conditions are cleared and will list any pre-funding conditions that must be satisfied. Most pre-funding conditions can usually only be satisfied at the closing table or within ten days of closing, so you’ll never receive a final loan commitment that is completely free of conditions.
It’s important for you to follow the steps in the process. While its good to know where you stand, don’t make the mistake of the homebuyers in the above example by pausing at pre-qualification and jumping into contract negotiations. Know your credit, gather your supporting documentation, research lending programs, and shop pricing and loan eligibility with different lenders.
Sylvia M. Gutiérrez is the author of Mortgage Matters: Demystifying the Loan Approval Maze. Miami: RealWorks Press, 2015. Print and eBook.