Prepare For The Mortgage (And The Shopping Will Be Easy)!

They're absolutely everywhere. Home buying guides and articles that all give potential home buyers information on how to prepare for the home buying process. And with a few exceptions, they all read pretty much the same:

• Find a Realtor
• Look at several houses
• Negotiate with the seller

While all of this may be good advice, none of it addresses the single most important aspect of the home buying process, the mortgage. I mean let's face it, you could find a new dream house for every day of the week, but if you can't get the money to buy these houses then you're just wasting time. However taking the time to get your financing pre-approved before you go house shopping will make your shopping experience much easier and improve your negotiating power dramatically.

So what exactly do I mean by getting your financing pre-approved? Full pre-approval means that an underwriter from your lender has reviewed your application, your credit, and your income documents to determine how much money that they would be willing to lend you for the purchase of a new home. They would then issue you a credit approval letter which states the maximum loan amount, interest rate, terms, etc. These pre-approvals are usually good for anywhere between 20 and 30 days.

Now when you go shopping for that new dream home, you have an exact price range that you know you are approved for and (figuratively speaking) you have your check in hand. This will help speed up the home buying process by eliminating all of those houses that you simply cannot afford to buy. Also, you will improve your negotiating power with the seller by showing them that

• You are a serious buyer
• You have your financing in order and are much more likely to close on your contract should they accept your offer.

In some cases you may even be able to get the seller to accept less than what they originally asked for their home simply because they know that you have the financial ability to close on the transaction.

As you can see, it is important to prepare for your mortgage before shopping for a home. This principal holds true whether you're a first time home buyer or a seasoned real estate investor.

Now let's discuss for a moment how a lender will review and evaluate your loan file. The person in charge of reviewing and approving or rejecting your loan request is called the underwriter. When an underwriter looks at a loan file, they are trying to determine one thing:

"How much risk does this loan present to the lender?"

If the loan is too risky, then it is rejected; if it is within acceptable risk perimeters, then it is approved with certain interest rates and terms offered.

Your Personal Credit

One of the most important elements of your mortgage file is your personal credit. Even if your loan is approved, it is still assigned a degree of risk. The higher a lender's level of risk, the higher the interest rate offered for that loan. A borrower's credit is usually the best indictor of the lender's risk on a particular loan. Credit is graded "A, B, C, or D." These letters usually line up with your credit score.

• "A" grade tends to be scores of 680 and up; with several, previous well established credit accounts and a good pay history.
• "B" grade tends to fall between scores of 620 to 680. Sometime referred to as Alt-A, this credit grade may show some late payments or possibly even a small open collection account.
• "C" grade covers scores between 580 and 620. More commonly referred to as sub-prime, this credit grade usually has some problems in recent history (several late payments, maxed out credit lines, some open collections, or even a judgment).
• "D" grade covers scores of 580 or less. Borrowers with recent bankruptcies and foreclosures as well as large numbers of collection accounts and late payments usually fall within this credit grade.

"A, B, and C" credit can usually obtain financing, depending upon their entire financial picture. Interest rates and terms will generally get worse the lower your credit grade is. "D" credit borrowers usually have a very hard time find financing and even if they can get a loan approved, they have to put up a large down payment and accept very high interest rates to get the deal done.

Documentation

The next area of your loan file that we'll discuss is the level of documentation that you will provide the lender. The purpose of providing documentation is to show the lender that the information you put on your loan application, for employment, income, and assets, is correct and valid. There several acceptable documentation levels available for borrowers. Here is a list of some of those levels and what is verified (or documented) with each.

• Full Documentation (Employment, Income, and Assets are all verified thru your documentation)
• Stated Income (Income is accepted as stated on the loan application; Employment and assets are verified)
• No Ratio, AKA No Income (income is not disclosed on application; Employment and Assets are verified)
• No Doc (Employment, Income, and Assets are all accepted as stated on loan application; nothing is verified).

Generally the less documentation you can provide, the higher the risk your loan will pose to the lender and the worse your interest rates and terms will be.

Full Documentation will provide you with the best rates and terms as well as the best chance for getting your loan approved. The documentation needed for this level include:

• W-2's for the last two years (full tax returns if you're self employed)
• Your last two pay stubs (YTD profit and loss statement if you're self employed)
• Your bank statements for the last 2 months

If you have this documentation available to you, then it is always recommended that you use this documentation level.

Income/Debt to Income Ratios

Simply put, you can only buy as much home as your income will support. If you make $25,000 per year, don't expect to be able to purchase a $150,000 home, unless you have a 30% to 35% down payment. Your debt to income ratio (DTI) will be one of the key items that the underwriter will look at when evaluating your loan file. DTI is calculated by taking your total monthly debts (car loan payments, credit cards, student loans, child support, alimony, etc), plus the extra debt of the proposed mortgage payment, and dividing it by your gross monthly income (before taxes income). The purpose of this is to see if your current income can handle the extra monthly debt of the new mortgage. "A" paper lenders like to see DTI's no higher than 36% to 38%; "B" credit lenders will usually allow up to 50% and sub prime lenders ("C" credit grade) will allow up to 55% DTI.

Assets

While passive assets (real estate holdings, long term mutual funds, etc) will make you look all the better to an underwriter, what a lender is really interested in is your liquid assets (in other words, your cash on hand). Do you have enough ready to spend cash available to cover the costs of your loan plus have enough left in the bank to cover 2 to 6 months of mortgage payments. Even if you are obtaining a no down payment loan and all of the costs are being paid by the seller, it is still necessary for you to have a few months worth of reserves sitting in the bank. Regardless of whether the lender requires it or not, it is an excellent idea to have yourself a safety net in case you run into some hard times financially.

Shopping for a new home can be a lot of fun, but let's face it; having to go thru the mortgage process can take that fun out of the situation for many. That's why it is important not only to understand how your mortgage request will be reviewed, but to also take care of that mortgage request before you go shopping. Having the knowledge of how much home you can afford and your mortgage is already taken care will make the home buying not only smoother, but that much more enjoyable as well.

John Worley is residential/commercial loan officer with over 5 years experience in the real estate business. His background includes residential real estate appraisal and residential/commercial real estate investing. For more information on John's current mortgage services and other helpful informational articles, log on to http://www.rtlgeorgia.com/

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