WHY PREAPPROVE FOR A LOAN?
Most of us know exactly what kind of home we want, though we may not know how we'll be able to afford it. Pre-approving for a loan allows you to see how much of a loan you can get. This part of the process will help you focus on homes in your appropriate price range. You'll also be appealing buyer from the seller's point of view. Especially in San Francisco, sellers often receive many offers and base their decisions on the best offer with the best terms. If you are not pre-approved, the seller does not have a clear sense of your ability to purchase and may not accept your offer.
Pre-qualification vs. Pre-approval
Pre-qualification allows a lender, using the information you provide, to tell you what loan amount you pre-qualify for. It is NOT a formal loan approval. It does not require paperwork and in today's real estate market, it holds very little weight in an offer situation.
Pre-approval means that you have completed an application for a loan, with all supporting documents, had your credit checked and the lender is willing to grant a loan of a specific amount to you. You now will be aware of the terms of the loan and can present an offer to the seller.
Your Credit Score
The credit score is a number assigned by one of three computerized national credit repositories (Equifax, TRW and Trans Union) used to determine your credit worthiness. Scores take into consideration your credit card history, types of credit, negative credit information and sometimes your income and time on your job. These scores are scaled across the separate bureaus so they should be similar. For most scoring models, the higher the score, the better, but for other models, the lower the score, the better. Mistakes can be made in credit reports, and can be corrected with proper documentation. It is a good idea for you to check your credit report as soon as you consider a purchase, so that you have time to clean up any errors.
Lenders don't have to tell you your credit score, and you don't have a legal right to demand it, though they are legally required to tell you why you were turned down. Factors affecting your qualifications to a lender tend to include things like past delinquencies, maxed out credit limits, the length of time you've had credit, and the mix of types of credit.
The use of credit scores by mortgage brokers has caused some criticism from those who see them as weighted against lower income borrowers, renters and first-time purchasers. Studies have shown that high income buyers don't repay their mortgages any more reliably than buyers with lower to moderate incomes.
Affordability
Your down payment, your ability to prequalify, and the estimated closing costs are important in determining how much you can afford.
Most loans will require between 10 and 20% of the price as a down payment. 25% may allow you to qualify for a special mortgage price. A less than 20% down payment may require Private Mortgage Insurance (PMI).
Most lenders will require that your monthly housing cost including principal, interest, taxes and insurance (or PITI) does not exceed 28% of your gross monthly income, and that your other debts do not exceed 36% of your gross monthly income. Lenders will likely review your employment history and tax returns, bonuses, commissions or child support. You'll need to explain in writing any information on your credit report that could negatively affect you. They will also calculate your assets, including bank balances, CDs, stocks and bonds. You may want to delay any other major purchases until you've purchased your home, and take care to keep your credit and payments on credit cards in good standing. Closing costs will vary from 2-5% of your loan and can sometimes be included in the loan. If not, they are due in cash at the close of escrow.
80-10-10 Deals
You might choose to get a traditional 80% first mortgage and additional home equity loan or second mortgage for 10% of the purchase price. While rates may be higher for this second loan, it allows you to avoid Private Mortgage Insurance (a mortgage default insurance designed to pay the lender a portion of the balance in case of a homeowner default).
90-10 Deals
The lender will lend you a 90% first loan and you put down 10%. In 90-10 loans, you must pay PMI (Private Mortgage Insurance) which varies according to the type and amount of the loan. It runs from .5-.75% of the loan amount for the first year of the loan. PMI does not disappear until your equity increases to at least 20 %.
Tax Advantages
You may be able to deduct part of your home ownership costs when you file your taxes. Interest and property taxes are often deductible items on federal and local returns. How much you can save will depend on your income and other itemized expenses. Your tax advisor can provide you with details.