By getting pre-qualified or pre-approved for a mortgage, you will have negotiating leverage because the seller knows that you already have a loan virtually in your pocket. And you won't be tempted to buy an unaffordable house.

Prequalification
Prequalification acts as a dry run of the loan application process. The mortgage lender will use details you provide about your credit, income, assets and debts to arrive at an estimate of how much mortgage you can afford. The whole process may take only minutes or a few hours at most, and is usually free.

While a "pre-qual" is non-binding to the lender (because the information you provide has not been verified), it does serve as a good indication to potential sellers of your general creditworthiness.

Preapproval
Pre-approval takes prequalification one step further. The lender will contact your employer, your bank and others to verify your income, assets, debts and credit history, and then issue you a letter stating that your mortgage is approved for a certain amount within a certain time. You may be charged a small fee to cover the cost of your credit reports and your application, often refunded at closing.

Gain the buying edge
The advantages of prequalification and pre-approval are twofold: you're more attractive to sellers, who needn't worry that they'll accept your offer only to have your loan turned down, and you'll save time to closing when you find a home because the lender will have already completed the necessary qualifying and underwriting steps.

Important note: Should your financial circumstances change before closing, make sure to contact your lender, as your prequalification or pre-approval may no longer be valid.

What lenders will ask (and how underwriters will evaluate the answers)

Your mortgage lender will want to know a lot about you before approving your loan application, and justifiably so; they and their underwriters want to be assured that you meet their minimum level of creditworthiness before lending you money.

Here are the general areas of questioning you can expect from a lender:

Employment and income: Where do you work? How much do you make? How long have you been at your job? How is your income derived -- steady salary or irregular income? If it's the latter, you may need to provide more details to obtain a favorable interest rate.
Outstanding debts: What recurring debts do you have? How much do you pay a month for auto loans? Credit cards? How much of your monthly pretax income do these debts consume?
Cash reserves and assets: How much money do you have in the bank? How much will be left after you pay your down payment and closing costs?
Down payment: How much money are you putting down? Is this your own money? If not, is it a gift from your parents? A nonprofit agency grant?
Loan purpose: Is this mortgage for a home buy or refinance? If it's a refinance, do you want to take cash out at closing to pay off other debts? If so, how much?
Property use: Do you plan to live in the house? Is it investment property?
Property type: Is it a single-family home? A condominium? A duplex?

The following responses tend to work in your favor:

Steady employment (two or more years) with the same employer or in same line of work.
Low debt: no recent major buys (such as automobiles) and a debt-to-income ratio of 36 percent or less.
Loan is for straight home purchase (or rate-and-term refinance).
Property is detached single-family home to be used as primary residence.
Down payment of at least 5 percent of sales price with your own money.
You'll have at least two months' worth of mortgage payments in the bank after closing.

These responses tend to work against you:

Self-employed or contract worker.
High debt: credit cards "maxed out," total debt-to-income ratio more than 36 percent.
Property is a duplex or condominium, to be used as a vacation home or rental.
No cash left after home buy and closing costs.
Down payment is 3 percent or less of buy price and money is borrowed.

Ten questions to ask

Once you've narrowed the lender field to a short list of finalists, it's time to compare their offers.

Here are the 10 key questions to ask at application time to help you find the best overall mortgage loan. If you have already selected a lender and are ready to apply, make sure you have the answers to these questions first.

1. What is the interest rate on this mortgage?
To determine exactly what you'll pay over the term of the loan, you need to know the rate. Rates change quickly, and if your credit is less than perfect, you may not be offered the lender's lowest figure.

To effectively compare different lenders' programs, ask for the annual percentage rate (APR) of the mortgage interest, which is generally higher than the initial quoted rate because it includes some fees. But beware: the APR found in advertisements can be misleading. Mortgage lenders don't always include all the fees they charge in the calculation that determines APR, so customers who use that figure to shop rather than an itemized breakdown of rates, points and fees may end up comparing apples to oranges.

2. How many discount and origination points will I pay?
Lenders may charge prepaid mortgage interest points to lower your interest rate or other points that have no benefit to you at all. Find out how many you'll be expected to pay and which kind of points they will be.

3. What are the closing costs?
Mortgages come with fees for various services provided by lenders and other parties involved in the transaction. You want to know what those fees will be as early as possible. Lenders are required to provide a written good faith estimate of closing costs within three days of receiving a loan application.

4. When can I lock the interest rate and what will it cost me to do so?
Your interest rate might fluctuate between the time you apply and closing. To prevent it from going up, you may want to lock the rate, and even points, for a specified period. Ask your lender if lock fees apply. Also, find out what the experts are expecting rates to do, read Rate Trend Index.

5. Is there a prepayment penalty on this loan?
There may be a prepayment penalty on your loan. Some penalties are 1 percent of the loan amount, others are equal to six months' interest, some apply only when you refinance or reduce the principal balance by more than 20 percent, and some kick in if you sell your home. Find out the duration of any penalty period and how the penalty is calculated. Some lenders offer lower interest rates to buyers who accept prepayment penalties.

6. What is the minimum down payment required for this loan?
The rate and terms of your loan will be based on a down payment figure, typically 3 to 20 percent of the buy price. If you can put more money down, you may be able to lower your rate and improve your terms; if you come up short, you may be required to get mortgage insurance.

7. What are the qualifying guidelines for this loan?
These requirements relate to your income, employment, assets, liabilities and credit history. First-time home buyer programs, VA loans and other government-sponsored mortgage programs typically offer easier qualifying guidelines than conventional loans.

8. What documents will I have to provide?
Most lenders will require proof of income and assets before approving your loan, and may require other documents as well. Buyers with excellent credit may qualify for a no-documentation or "no-doc" loan, but they can expect to pay a hefty down payment and higher interest rate.

9. How long will it take to process my loan application?
The answer will depend on a number of variables. When the loan business is brisk, underwriters get backed up, verification takes longer, appraisals move slower and other bottlenecks develop along the loan pipeline. Lenders may say two weeks, but 45 to 60 days is probably more realistic in most cases. You'll need their best guess to determine how long to lock in your loan.

10. What might delay approval of my loan?
If you provide the lender with complete, accurate information, the loan process should run smoothly. If the underwriter discovers credit problems, however, there could be delays. Make sure you notify your lender if you change jobs, increase or decrease your salary, incur additional debt or change marital status between the time you submit an application and the time the loan is funded.

Put these 10 questions to your leading candidates and compare their answers. The results should lead you toward the mortgage lender that is right for you.

Necessary paperwork for a buyer

Mortgage lenders may require proof of your assets, income, credit quality and other financial information.

Here are some documents you may want to gather in case the lender needs them:

Federal tax returns and W-2 forms from the past two years.
At least one recent paycheck stub showing your name and Social Security number, the name and address of your employer, and your year-to-date earnings (some lenders will want the most recent month's worth of paycheck stubs).
Proof of other income: a second job, overtime, commissions/bonuses, interest and dividends, Social Security disbursements, VA and retirement benefits, alimony and child support.
List of creditors, including credit card issuers, student loans, car loans, child support and alimony. You may be asked to show proof of your minimum monthly payments and total balances, too.
Investment records: mutual fund statements, real estate and automobile licenses, stock certificates and proof of other investments or assets.
Canceled checks showing mortgage or rent payments.
Home sales contract, including the purchase price, if you've found the house you want to buy.

Not all lenders and loan programs will require all of this documentation, and borrowers with very strong credit scores may need to provide little or any of it. But having it handy may save valuable time during the application process.

The good faith estimate

Your lender is required by the federal Real Estate Settlement Procedures Act to provide you with a good faith estimate of the fees due at closing. This document, called the good faith estimate, or GFE, is supposed to be provided to you within three days of applying for a loan. The requirement is satisfied if the good faith estimate is mailed within three days.

The closing fees, also called settlement costs, cover almost every expense associated with your home loan. Because closing costs typically amount to between 3 and 5 percent of the sale price, it is best to wait until you receive the good faith estimate before committing to a loan. Smart shoppers obtain good faith estimates from two or more lenders, compare their costs, and ask questions about any large discrepancies.

Here's a list of some of the fees you'll find listed on your good faith estimate:

Origination
Discount
Property appraisal
Credit report
Lender's inspection
Mortgage insurance application
Assumption
Mortgage broker fee
Tax related service fee
Application
Commitment
Rate lock
Processing
Underwriting
Wire transfer
Settlement, closing or escrow fee
Abstract or title search
Title examination
Document preparation
Notary
Attorney
Title insurance
Recording
City/county tax stamps
Transfer tax
Survey
Pest inspection
Condominium application
Prepaids for interest, hazard insurance, property taxes and mortgage insurance and flood insurance

It's just an estimate
The good faith estimate is just that -- an estimate. The lender directly controls some of the fees, and those are the ones to pay the most attention to when you are comparing offers. Some fees are performed by third parties, and usually don't vary much from lender to lender. Other expenses are under your control, and there are taxes and government fees that should be the same, regardless of the lender.

Lender-controlled fees
The fees that the lender controls, and which are most subject to negotiation, are origination, discount, credit reporting, assumption, mortgage broker, tax related service, application, commitment, rate lock, processing, underwriting and wire transfer fees.

If a fee seems vague or questionable, ask. Some mortgage companies include so-called junk fees that you can eliminate or reduce.

Third-party fees
There are some fees that cover services that the lender typically shops for. The lender is supposed to pass these fees directly to you, without marking them up. These third-party fees include the settlement, closing or service fee; appraisal; abstract or title search; title examination; document preparation; notary; attorney, and title insurance.

You don't have a lot of negotiating room on these fees, but if one is much higher or lower than the comparable fee in a competing offer, ask for an explanation.

Fees for services that you can shop for
There is some overlap here with the third-party fees mentioned above -- specifically, the attorney's fees or settlement, closing or service fees. In some states, the closing is done by attorneys, and in other states, the closing is done at a title office. Either way, you can shop for a less expensive closing-service provider. You also are expected to shop for homeowners insurance instead of taking the lender's estimate as gospel.

Non-negotiable stuff
Your local and state governments will charge recording fees, tax stamps and transfer taxes. There's not much you can do to negotiate those.

Be skeptical
Lenders, especially those that are huge and operate nationwide, often have trouble estimating title insurance and government fees. Scrutinize these line items; the lender with the smaller estimate for title insurance or government fees might be inaccurate. National lenders have particular trouble estimating the buyer's cost for title insurance -- not because they estimate the price wrong, but because of varying customs regarding who pays what. In one county, the seller might customarily pay for title insurance, while in the adjoining county, the custom is for the buyer to pay for title insurance.

Remember, you can always negotiate with the seller to have them split or pay outright some of the closing costs, points or fees. You don't have to follow the customs of your area.

Your time of the month
Because all mortgage loan payments are due on the first of the month, you can avoid or reduce the prepaid interest due by closing on or near the last day of the month.

Other lender paperwork

Here is a list of disclosures (besides the good faith estimate) that your lender must provide to you within three business days from the time you apply for a loan:

Truth in Lending Act statement (TILA)
The federal Truth in Lending Act requires lenders to disclose in writing the terms and conditions of a mortgage, including the annual percentage rate (APR) and other fees and charges.

Unfortunately, lenders may lawfully exclude certain fees, including property appraisal, title search and insurance, notary and some recording fees, credit report and flood certification, leaving home buyers without an "apples-to-apples" comparison of loan costs.

Ask your lender to break down your TILA statement for you. If the information changes, the lender is obligated to provide you with an updated form at or before closing.

Servicing disclosure statement
Federal law requires your lender to disclose to you whether they believe someone else will eventually be your mortgage servicer, that is, collect payments, handle disputes, send out escrow statements and perform other functions after a loan closes.

Affiliated business arrangement disclosure
In addition to these federally required forms, if you apply for a loan from a mortgage company operated by a builder or real estate agent, you should receive an affiliated business arrangement disclosure at the time the builder or agent refers you to that company. This form simply states that you are not required to use the services of the affiliated company and are free to shop for a mortgage elsewhere.

Mortgage Basics - Chapter 4: Paperwork and fees

A lot of trees are killed just so you can buy a house: the amount of paperwork is daunting. The lender will ask you for documentation of employment, income, debts, savings, and the source of your down payment money. To back up your claims, you might have to provide tax returns, paycheck stubs, checking statements, investment records, and a copy of the home sale contract.

After you apply, the lender will give you a stack of paperwork. The most important document is called the good faith estimate of closing costs. It has to be given or mailed to you within three days of application, and it lists the fees that will be charged in connection to the home sale and the mortgage.

While you are trying to make sense of all the paperwork you received, the lender and various third parties are doing their work behind the scenes.

Behind the scenes

Once your loan has been approved, the clock starts ticking to closing day. Much remains to be done during those few weeks, and most of it occurs behind the scenes. You can help speed the process by

Providing complete documentation with your application.
Responding promptly to your lender's request for more information.
Calling your lender and real estate agent to check on your loan application status.
Helping contact employers and others who may need to provide documentation.
Keeping records of your conversations with your lender.

Here's what's happening while you wait:

Underwriting verification
Your lender's team of underwriters springs into action, verifying the information on your application and supporting documents. They will call your employer, for instance, to verify that you work in the job and at the salary stated on your application. The amount of verification involved depends on how risky your lender perceives you to be.

Appraisal
Your lender will require an independent appraisal of the property prior to closing, the outcome of which could affect the rate and terms of your mortgage. The work will be done by a licensed appraiser, who will arrive at an expert's estimated value of the property based on physical inspection and a sampling of comparables or "comps" -- prices paid for comparable properties that have recently sold in the neighborhood. Cost of an appraisal typically runs between $300 and $500.

Title search and title insurance
Your lender doesn't want to lend money against a house that may have claims or other encumbrances upon it. That's why a title company performs a title search.

The title company will go to the county courthouse and research the history of the property, looking for encumbrances such as mortgages, claims, liens, easement rights, zoning ordinances, pending legal action, unpaid taxes and restrictive covenants. The title insurer then issues a policy that guarantees the accuracy of the work. Your lender will require a title policy that protects the lender. In some cases two policies are issued, one to protect the lender and one to protect the property owner.

Flood certification
Lenders also want to know whether the property you're buying is in a flood-prone area. They will hire a vendor to analyze your property and neighboring sites to determine if it's in a flood zone; their report is called a flood certification. If the answer is yes, you'll be required to buy flood insurance because most standard homeowners' policies don't cover damage from rising water.

Survey
Some lenders also will require that a home's property lines be verified by a professional survey.

Inspection and insurance

While the lender and third parties are preparing your loan for closing, there are a couple of things for you to tackle. You probably will want to have the home inspected, and you will be required to buy homeowners insurance

Home inspection
Home inspection is commonly required to determine the structural and mechanical condition of the home you're buying, including the roof, heating, plumbing, air conditioning and electrical wiring. The inspection may reveal the need for repairs that the seller may have to complete before the sale of the house can go through.

It's a good idea to have the home inspected after you agree on a price but before signing the contract and putting down a deposit. If you're in a hurry to lock in the deal, make sure your contract states that the terms are conditioned on a satisfactory professional inspection. The cost of a home inspection typically ranges between $250 and $500.

Homeowners insurance
After the home has been appraised, you'll be in a better position to obtain adequate insurance.

Coverage comes in two types: a replacement cost policy or a cash value policy.

With a replacement cost policy, a 20-year-old camera destroyed in a storm would be replaced with an equivalent new model, while with a cash value policy, you would receive nothing for the camera because the item has lost its value over time. Owners of older dwellings and contents tend to prefer the replacement cost policy, which may cost 10 percent more; owners of newer houses and furnishings should consider cash-value policies.

Whichever policy you choose, be sure to ask your insurance agent about safety features such as deadbolts, storm shutters and security systems you can install to reduce your premium.

Special circumstances

Some home buyers fall into a gray area that will cause a lender to reject the loan, require additional information to approve it, or modify the terms. Many special circumstances are indeed circumstantial; perhaps you have been at your current job for less than a year, show a few late payments on your credit report or are self-employed.

Here are tips on dealing with the following special mortgage loan situations:

A problem appraisal
Buying a condominium or town house
"No-doc" or "low-doc" loans
Flawed credit

A problem appraisal
Sometimes the property is appraised for less than you have agreed to pay for it. This can create problems, especially if your down payment is small and the appraised value falls below the amount that you want to borrow.

If the appraisal falls short of the loan amount, you might have to come up with a larger down payment or renegotiate the sale price before the lender will lend you the money at all. Say, for example, you intend to borrow $97,000 to buy a $100,000 house. But the appraiser says the house is worth $95,000. The lender isn't going to give you a $97,000 loan for a house that's worth $95,000. Either you will have to negotiate a lower price for the house, or you will have to pay the original price but come up with a bigger down payment and borrow less than $95,000.

Buying a condominium or townhouse
When you buy a condominium or townhouse, as opposed to a single-family detached home, you generally receive exclusive ownership of the interior space of your unit and joint ownership of the common areas (walls, grounds, fences, facilities) with the other owners in the complex. In the case of a townhouse, you might also own a backyard and garage.

Your mortgage lender will want to investigate the complex from both a financial and physical standpoint to avoid making a loan on a troubled condominium. Most lenders have a questionnaire that the condo association can complete to help the lender analyze the project and decide whether it is acceptable collateral for a loan. The lender will pay particular attention to these details:

Percentage of owner-occupied vs. rented units. Most lenders want to see 60 percent or more of the complex owner-occupied.
Is the construction finished? Most lenders require that it be at least 90 percent complete.
Adequate insurance coverage, including hazard insurance.
Acceptable operating budget.
Competent management.
Adequate reserves to cover maintenance and major repairs, such as roofing or elevators.

Make sure you receive from the seller the condo documents, articles of incorporation and the bylaws of the homeowners' association. These should include notification of any ongoing litigation and special assessments. You may also want to ask for minutes of the homeowners' association meetings for the past year. Read the condo documentation carefully and make your approval a condition of the buy. Most states have enacted laws governing the sale of condominiums; check with your state's division of real estate.

No-doc or low-doc loans
No-documentation ("no-doc") or low-documentation ("lo-doc") loans are designed for entrepreneurs or the self-employed, recent immigrants, and borrowers who cannot (or choose not to) reveal information about their incomes. You can expect to pay a slightly higher interest rate for these loans, often as much as one-half percent.

To secure a no-doc loan, you will need to pay a substantial down payment of 20 percent to 35 percent, have excellent credit history and verifiable assets to cover closing costs. For a low-doc loan, you must be self-employed for at least two years and provide proof of sufficient assets and excellent credit.

Home buyers with the available cash can secure a no-doc or low-doc loan and then refinance their home later by switching to a lower-rate, full-documentation loan when their financial records better match the lender's requirements.

Low- and no-documentation loans are sometimes called "Alt-A" mortgages because they are alternative type of "A" mortgage -- that is, a mortgage for a borrower with good credit. In olden days, loans for people with flawed credit were called B, C or D loans, but now lenders use the catch-all term "subprime."

Flawed credit
You probably are aware of any serious problems in your credit history. But what if you are taken by surprise, and you have such flawed credit that your credit score is below 620? You can get a home loan, but it will be a subprime mortgage, with less favorable rate and terms.

Turned down for a mortgage

A common nightmare keeps most first-time home buyers awake at night: What if I get turned down for my mortgage loan? While it is natural to fret about this worst-case scenario, the chances of it actually happening are quite slim given the popularity of pre-approval and the myriad ways mortgage lenders can adjust loan terms to get you the loan you both want.

Still, say it happens and you get the big red "Denied" stamped on your loan application. Here are three things to do right away:

1. Find out what happened
Your lender has 30 days from your application date to explain in writing why the loan was denied. This explanation, called an "adverse action notice," must state a specific reason for the denial. It also will tell you which federal agency to contact if you think the lender or mortgage broker has illegally discriminated against you.

The good news is that the three most common reasons for denial can be corrected in time: insufficient down payment, excessive debt and poor credit history. You can apply again once you have saved more money, paid down your car loan or credit card debt, or raised your credit score by diligently paying your bills on time for a while.

2. Request a second opinion
Some lenders offer a second level of review for mortgage loans to which you can plead your case. You may yet qualify if you can convince the secondary loan reviewer that your credit history was marred by an isolated cataclysmic event, such as unexpected hospital bills that ruined your finances.

3. Keep shopping
Just because one lender turns you down doesn't mean there aren't a dozen ready to approve your loan. Banks and mortgage companies set different underwriting criteria based on their own business objectives. Find one that's right for you.

Summary

After you apply for a mortgage and before you go to closing, the loan goes through the underwriting process. The lender will verify the information that you supplied about yourself and your finances, hire an appraiser, commission a title search, get title insurance, secure a flood certificate and get survey work done, if necessary.

If the underwriting process doesn't go your way -- in other words, if your loan application is denied -- you should find out what happened, get a second opinion and keep on shopping if the answer is still no.

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Robert Hershey
Associate Broker /
Multi-Million Dollar Producer
480.980.7653
bhershey@cox.net