Mortgage Prequalification versus Mortgage Preapproval

Mortgage Prequalification versus Mortgage Preapproval

What's the difference between mortgage prequalification and mortgage preapproval? Which one is better?

Pre-qualification is preferable to pre-approved. Pre-qualification means that a lender has assessed and verified your income, assets, current debts, and credit score, and determined your ability to close the loan, your ability to re-pay the loan, and the size of loan they will lend to you. A pre-approval is a less rigorous review of your financial state than a pre-qualification; while a lender will assess your income and credit score, limited verification steps are normally taken.

In either case, your lender will provide you with a letter that you may share with your offer contract. Typically a pre-qualification letter can be completed in a matter of hours, although some lenders may take longer.

How Does Getting Pre-Qualified Benefit You?

· You will be able to shop with the confidence of knowing your exact price range.

· You can identify credit problems that can be addressed early in the lending process.

· You will typically have more negotiating power, as some sellers see more strength in offers from pre-qualified buyers.

· If you are self-employed or a commission-based buyer, pre-qualification can demonstrate financial backing if your income fluctuates more than those of salaried buyers.

· Pre-qualification gives first-time homebuyers the advantage of equalizing their offer with similar offers made by \ previous homeowners.

Other Pre-Qualification Facts?

· Pre-qualification is offered by most lenders, including at no cost.

· The pre-qualification process is not comprehensive and therefore is not guaranteed, nor is it considered any type of loan commitment. It simply shows that you’ve approached a lender who was serious about helping you determine what you can afford and will walk you through the process.

 

Why you should maintain a good FICO score

Derived from your credit history report, credit scores are based on points you receive for being a good borrower. The most common scoring system used for mortgage approvals is done by the Fair Issac Corporation (FICO), which accesses the three main credit reporting bureaus (Equifax, TransUnion, and Experian.)

Credit scores can range from a low of 300 points to a high of 850. People with average credit usually score around 620, good credit at 660, and excellent credit above 740. People with higher credit scores more easily obtain mortgage loans and also are able to secure lower interest rates vs. those with lower scores.

Example

Let’s imagine a 30 year fixed mortgage of $300,000. Someone with a credit score of 740 or higher could get a loan at a 4.125% interest rate, and a monthly payment of $1454. Another person with a credit score of 660, however, would get a loan with a higher interest rate of 4.625% and a monthly payment of $1542, a monthly difference of $88 (or annual difference of $1056). Over the life of the loan, this person would pay $31,849 more in interest as compared to the person with a 740 credit score. Another person with a credit score of 620 or below would have an even higher rate and payment, if they were even able to get a mortgage loan.

How to get the best rate

A good strategy for securing the best rate would be to clean-up your credit report at least six months prior to applying for a mortgage loan. Anyone may obtain their credit report for free once a year from www.annualcreditreport.com. Maintaining a debt-to-income ratio of less than 36% could boost your score by as much as 10%. Lenders like to see a history of long-term credit and ability to pay off a loan over time. The goal of any loan applicant should be to make sure their credit report is as accurate and sound as possible.

After you are under contract on a new home, your lender will complete the full loan approval process, lock-in your interest rate for a specified period of time (usually 30 to 60 days), and provide you with an estimate of your closing costs and monthly payments.

Find the best mortgage rates.

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Getting the Type of Mortgage that Is Best For You

Getting the Type of Mortgage that Is Best For You

Choosing a mortgage loan should seem like a straightforward process; you borrow money from a lender for a specified amount, for a set period of time, and pay it back. However, getting a loan you feel comfortable with, one that's flexible during good times and bad, can be a challenge.

Mortgage loans basically fall into one of two categories: government or conventional. Government loans are normally insured by the Federal Housing Administration (FHA) or the Veteran's Administration (VA). Some offer lower down payments and most offer favorable terms.

Conventional loans can be either conforming or non-conforming. Conforming loans follow the guidelines set forth by The Federal National Mortgage Administration (Fannie Mae) and The Federal Home Loan Mortgage Corporation (Freddie Mac). These types of loans can be either fixed or adjustable. Each is tied into a specific rate, term and limit which can vary from lender to lender. Non-conforming loans, on the other hand, do not adhere to any strict guidelines.

How do fixed-rate mortgages work?

Fixed-rate mortgages retain the same APR throughout the life of the loan. However, the property tax and homeowner's insurance, if built into the cost of the loan, may change over time. The most popular type of fixed loan is a 30-year term.

For those who prefer a shorter timeframe, a 15-year fixed mortgage may be a better option. While the amount of time it takes to repay is shorter, you can usually secure a better interest rate (.25-.50% lower than a 30-year fixed). Besides a 15- and 30-year term, fixed loans are also available 40- and 20-year terms.

Here are some other benefits and drawbacks that a conforming fixed loan has to offer.

Conforming Fixed Mortgage Loan Types

Types of Mortgages Advantages Disadvantages

15- or 20-Year Fixed

  • Interest rate and payment locked-in for the duration of the term should interest rates rise
  • Shorter amortization period allows for a quicker loan repayment leading to equity build-up
  • If interest rates go down you’re still locked-in to your original rate unless you refinance
  • Higher monthly payments than a longer term loan

30- and 40-Year Fixed

  • Interest rate and payment locked-in for the duration of the term should interest rates rise
  • Lower monthly payments due to a longer amortization period
  • If interest rates go down you’re still locked in to your original rate unless you refinance
  • Slow equity build-up since initial payments are mostly interest

How do adjustable rate mortgages work?

Unlike fixed-rate mortgages, Adjustable Rate Mortgages (ARMs) are based on shorter term securities that fluctuate upward or downward based on today's leading indexes (e.g., Constant Maturity Treasury (CMT), London Interbank Offering Rate (LIBOR), or Treasury Bill). A margin is added on top of the index rate by the lender to calculate the interest rate.

Because ARMs are adjustable, they go up and down at pre-set intervals during the duration of the loan. Some offer a low teaser rate to qualify potential buyers which accelerates to a higher rate thereafter. ARMs can adjust once a year, every month, or three to five years, and are typically amortized over a 30 year period. Some offer a lifetime cap which sets the maximum rate that can be charged during the life of the loan with some states having their own percentage limits.

Here are some of the benefits and drawbacks that an adjustable loan has to offer.

Conforming Adjustable Mortgage Loan Types

Types of Mortgages Advantages Disadvantages

Adjustable Rate Mortgage (ARM)

  • Lower payments can make it more attractive to qualify for a larger home
  • Some loans allow an option to convert to a fixed rate

 

  • Rates can adjust upward each year increasing your monthly payments
  • May require a conversion fee

Interest-only ARM

  • Affordable monthly payments during the initial interest-only period of the loan
  • Can refinance or pay off the loan after the interest only period
  • Can invest your principal savings into a higher yielding investment
  • Higher monthly principal and interest payments once the interest-only payment period ends
  • May not be disciplined in saving up for the pay-off amount
  • Initial interest payments go toward paying down a debt and not reducing the principal balance

Lower your payment with an Interest-only ARM loan

Another variation of the ARM is the Interest-only adjustable rate mortgage. This loan makes it affordable for borrowers to qualify for a loan by giving them the option to pay only the interest (not the principal) for the first 3-10 years of the loan. Monthly payments are usually more affordable. Afterwards, the interest rate adjusts to a traditional ARM at the current indexed interest rate with new principal and interest payments calculated for the remaining term of the loan.

Example

A 30-year ARM loan of $250,000 at 7.50% APR has interest-only payments for 5 years. The payment during this time would be $1,522 per month. After 5 years, the payment would increase to $1,816 per month.

A comparison of all the different loan types shows the potential cost savings you can achieve during the first five years of an interest-only loan versus other conventional loans.

Monthly Payment Comparison for Different Loan Types
Type of Mortgage
Loan Amount
APR*

 

 

Monthly Payment**
30/5 year Interest-only ARM
$250,000
7.31%
$1,522.00
30 year fixed
$250,000
6.17%
$1,720.35
15 year fixed
$250,000
6.05%
$2,429.02
1 year ARM
$250,000
7.67%
$1,987.85
3/1 ARM
$250,000
7.40%
$1,915.98
5/1 ARM
$250,000
7.21%
$1,894.23

 

 

* APR based on national average and may vary.

** Monthly payment includes principal and interest except Interest-only ARM which is interest-only for the first 5 years then jumps to $1,816.59 for the remaining 25 years (principal and interest included.)

Sub-prime loans

Borrowers who have a low FICO score will usually fall into the less than perfect mortgage category. As a result, they'll qualify for a loan but at a much higher rate. Lenders may apply stiffer pre-payment penalty fees in the form of interest payments to dissuade borrowers from building up any equity in their home. Some lenders may require a " balloon" payment to pay off the remaining balance of the loan after a fixed period of time.

Compare the best mortgage rates.

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How Will You Fund the Down Payment of Your New Home

How Will You Fund the Down Payment of Your New Home

One of the components a lender uses to help determine what loan amount to approve is your down payment. A down payment not only serves as a commitment on a borrower's behalf to make good on a loan, but also acts as a lender's guarantee to minimize risk in case a borrower defaults on a loan. The more of your own cash that you can put down for a loan, the easier it is to qualify for a higher loan amount or a lower mortgage payment.

One of the components a lender uses to help determine what loan amount to approve is your down payment. A down payment not only serves as a commitment on a borrower's behalf to make good on a loan, but also acts as a lender's guarantee to minimize risk in case a borrower defaults on a loan. The more of your own cash that you can put down for a loan, the easier it is to qualify for a higher loan amount or a lower mortgage payment.

Alternative sources of funding

Since most borrowers do not have large cash reserves on-hand for a down payment, there are other alternative sources for funding. Besides tapping into your own savings accounts, other resources may include relatives, 401(k) plans, proceeds from stock sales, appraised assets, even a co-signer.

Many cities, looking to expand their communities, even offer their own down payment subsidy programs for first time homebuyers. It's not uncommon to be gifted $5,000 to $30,000 without expectation of re-payment.

Loan-to-value ratio

A down payment is always expressed as a percent of the sales price and often referred to by lenders at the "loan-to-value ratio" or LTV. For instance, a $250,000 mortgage with an LTV of 80% would require 20% down or $50,000. Using a down payment calculator can help you see what influence a different down payment can have on your monthly mortgage.

Other down payment options

Some banks even offer zero-down percentage loans which require no down payment. These types of loans are typically directed at first-time buyers with good credit who are qualified to make the monthly payment but cannot come up with a down payment. However, without a down payment the buyer has no equity in the house and the lender is at greater risk, so the interest rate could be higher.

Another alternative to buying a home without committing to a down payment is to consider a lease option to buy. As a renter, you have an option anytime during the term of the lease to buy the property at an agreed upon price from the owner. In some instances, the money you've put toward rent can be fully or partially applied toward the down payment.

Sellers can also assist buyers with their down payment. By offering a carry-back mortgage, sellers can sell their house faster in a competitive market and buyers can purchase a home they otherwise might not be able to afford.

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