Mortgage Pre Approval: How They Calculate Qualifications

Getting a mortgage loan  has become a rite of passage for those pursuing the American Dream. Home ownership is a bulwark of the American Nation and a symbol of power and freedom.  A man's home is truly his castle. But on the way to home ownership a person has to jump through a lot of hoops, proving his financial worth and credit responsibility. It's not an easy process, but one which most people are willing to go through for their own place they can call home.

Pre-Approval

Before you go out looking for you dream house, you need to first speak with a lender who will get you a mortgage pre-approval. This pre-approval  is essentially  a promise from the lending institution that according to them you are qualified to borrow a particular amount of money at a particular interest rate. Of course, before any money will be loaned, the promise is subject to an appraisal of the property and other conditions.

The process involves the lender first examining your credit and verifying you income amount. The big difference between the mortgage pre approval and a pre-qualification is that with a pre qualification these numbers aren't verified. Once you are pre-approved, the lender will send you a pre-approval letter which states that your loan will be approved at the time you make an offer on a new home. It also requires you to submit certain documents, including:

  1. Preliminary title information;
  2. The purchase contract;
  3. The appraisal; and
  4. Your asset and income documentation.

Nevertheless, should you follow all these steps it is not an absolute guarantee that the loan will be approved.

By receiving the pre-approval the lender is making the statement of assurance that you can make the required down payment and that the money you bring in will sufficiently cover the monthly mortgage payments. Once that assurance is met, the lender needs verification of the property's value, ensuring that it represents sufficient collateral in terms of the loan amount;  essentially meaning that the property appraises for an equal or greater amount than the purchase price.

The Importance of Pre-Approval

In order to be taken serious by the seller - as well as your real estate agent - you will want to be able to produce a pre-approval letter. It assures these parties that you will be able to make the purchase, and not simply produce  an empty offer. Should there be any competition for the property you intend to purchase a pre-approval will be an advantage over someone without one since the seller is assured that you will be able to get the money necessary to buy his house.

Pre-Approval Process

There are three basic phases to the mortgage application process; these are the pre-qualification, the pre-approval, and the mortgage commitment itself.

Pre-Qualification

The first phase is not too difficult: getting prequalified. This is an informal process where a mortgage professional will ask you about your income, expenses and debts. All this stage does is give you a general idea of the price range of houses you can look at and expect to be able to buy. It doesn't help you secure a loan, per se, but it does get you moving and looking (for a house) in the right direction.

Pre-Approval

This stage is much more involved and means a great deal more. The lender will examine your credit report, your income and your employment history and with this information will determine what kind of loan programs you qualify for. He will also tell you the maximum amount that you will be able to borrow and the interest rates that will be available to you. This loan representative, though giving you accurate information, is not the one who approves loans. Underwriters approve loans, but this underwriting process is now automated.  

The loan representative will submit your application for pre-approval, but only after you have given him your last two years of tax returns along with W-2's, the most recent pay stubs you have received, a signed authorization to order your credit report, and possibly several months worth of  bank statements. The automated  underwriting system is then able to produce a pre-approval letter within minutes, listing conditions which will need to be met prior to a full approval.

Mortgage Commitment

After both you and the property have been approved through this process, the lender will then issue a loan commitment. Once all the required documents have been examined which prove your willingness and ability  to repay the loan, the complete application is submitted to the underwriter. The underwriter will come back with one of four possible outcomes: approved; approved with conditions; suspended (meaning they need additional documentation); or denied.

Mortgage Calculations

In determining the amount you will qualify and if you will be pre-approved, ratios of you income and debt will be calculated.

  • Your front mortgage ratios are calculated by taking your total monthly housing expense, which is principal, interest, insurance and taxes, and dividing it by your total monthly pre-taxed income.
  • The back mortgage ratio is determined by taking you total housing expense along with all other monthly debts and obligations and dividing that by your total pre-tax income.   In the case of credit cards, the minimum monthly payment is used.   In the case of car loans and other installment debts, if there is less than 10 months on the loan, the debt is ignored for the qualification process.
  • With traditional underwriting standards, most people are restricted to a 28/36 ratio.   Electronic underwriting has provided higher ratios.   These new systems analyze your credit history, reserves, job stability and other input and for well qualified borrowers allowing a ratio of 40/49.

Speak with a Loan Officer

For the latest information regarding qualification procedures and for specific questions you might have as to how mortgage pre approvals are calculated, contact a loan officer, or real estate agent who might be able to give you specific information.

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