There are six distinct phases of the mortgage loan process: pre-approval, house shopping; mortgage application; loan processing; underwriting and closing. Here’s what you need to know about each step.
1. Mortgage Pre-Approval
A loan pre-approval sets you up for a smooth home buying experience.
A few things have changed since the real estate meltdown a few years ago. For purchase transactions, real estate agents will first want to know if you can get a loan. In the old days, financial institutions were doling out money to anyone with a heartbeat. Unfortunately, soft lending standards helped fuel an eventual rash of foreclosures. Suffice it to say, conditions on the ground have changed since then. Today, the best way to approach a real estate agent is with a lender pre-approval in hand. It shows that you’re ready and able to buy.
Pre-approvals don’t take much time. They involve pulling a three-bureau credit report (called a tri-merge) that shows your credit score and credit history as reported by third-party, respected institutions. Within the credit report, a lender can see your payment history (to see if payment obligations have been on-time and in-full) and your lines of credit (past and present).
You lender will be able to pinpoint a loan amount for which you qualify. This pre-approval will save you a lot of time since you will be able to focus exclusively on houses in your price range.
Mortgage pre-approvals also signal to the seller that you’re a serious buyer. Being prepared is particularly useful when making an offer on a house. If you intend to negotiate the deal (and why wouldn’t you?), a pre-approval gives your offer a little extra gravity. Being ready to go can also help in a hot market where it’s not uncommon for sellers to entertain multiple, simultaneous offers. Sellers tend to focus on the path of least resistance: the buyer who is pre-approved.
As you do your online research, you may read the term mortgage pre-qualification. It is not the same as pre-approval, and it’s important to know the difference.
A pre-qualification is a less meaningful measure of a person’s actual ability to get a loan. It’s a very lightweight “at a glance” look at a borrower’s credit and capacity to repay a mortgage. It’s usually determined by a loan officer asking a potential borrower a few basic questions like, “How is your credit?” There’s no third-party verification of the borrower’s answers. While the conversation with a loan officer can be helpful for other reasons, there’s no tangible result that proves anything to anyone (like to your real estate agent or a seller).
During the pre-approval phase, one of the best things to do is to gather up documents needed for mortgage pre-approval. Anything you can do, to prepare in advance, will reduce the stress when you find the right home and make an offer. At that stage, you’ll be able to hand over all your paperwork to your loan officer at once. Being ready is a solid move! You can even download a pre-approval document checklist.
2. House Shopping
You may have already started shopping online via real estate portals like Zillow, Trulia or Redfin. At this stage, it’s a good idea to start working with a real estate agent and viewing homes.
Shopping for houses online is convenient, easy and fun. There are a few things you’ll want to know in advance.
First, none of the online resources are 100% accurate. In fact, Zillow’s home price estimates, called Zestimates, are off nationally by about 8%. And that’s at a very broad, national level. The accuracy can drop even more as shoppers drill down to specific towns and neighborhoods. Zestimate inaccuracy isn’t necessarily a bad thing, it’s just something a smart shopper should know. There’re still a lot of reasons to use a real estate shopping and comparison.
There’s a strategy that can help you deal with Zestimates. The 8% inaccuracy cited above can swing in either direction. Zestimates can be high or low. Here’s what that means to you. If you are pre-approved for a $400,000 loan, that means you could include searches on homes up to $432,000 (8% greater than the $400,000 baseline approval). You real estate agent can help you fine tune your choices. An experienced realtor, with a good understanding of the local market, will have a sense about which homes may be negotiated down to a price you can afford.
The second thing you’ll want to know is that listings on big real estate portals are not always up-to-date. Multiple Listing Services (MLS), used by real estate agents, reflect the most up-to-date inventory.
Lastly, for whatever technical reason, portals don’t show 100% of the available inventory. Furthermore, agents may know about homes that are coming on the market before the listings are made public. It’s good to have a professional with his or her ear on the ground in the market where you want to buy.
Real estate shopping engines are great for:
- Searching by location using map-based queries
- Getting ideas about neighborhoods that fall in your price range
- Putting together a list of properties you want to see in person
They are not as good at:
- Predicting a precise and final sales price
- Showing all listings in the market
- Revealing listings that will hit the market soon
Make an Offer
When you’ve visited properties with your agent and picked out the home you want, it’s time to make an offer. Your real estate agent will know the ins-and-outs of how to structure it. It will include contingencies (or conditions) that must be satisfied before the deal is complete. Here are a few common ones:
- Appraisal must come in close to the loan amount, not lower
- Home inspection does not find issues with property
- Borrower is approved for loan
In fact, HUD mandates a VA Escape Clause on every purchase offer.
It is expressly agreed that, notwithstanding any other provisions of this contract, the purchaser shall not incur any penalty by forfeiture of earnest money or otherwise or be obligated to complete the purchase of the property described herein, if the contract purchase price or cost exceeds the reasonable value of the property established by the Department of Veterans Affairs.
Contingencies protect you and your earnest money, a deposit that tells the seller you’re a committed buyer. Typical earnest money deposits are 1% to 2% of the sale price. The funds are released from escrow and applied to your down payment at closing.
With terms of the deal approved by both parties, the purchase agreement (a binding offer) is signed by the seller and buyer. At this point, you can move forward to finalize the loan.
3. Mortgage Loan Application
Applying for a Mortgage
A few documents are needed to get a loan file through underwriting. Some of the information will be gathered online or over the phone. A lot of it will already be stated on some documents you’ll provide, like employer address which can be found on a pay stub. While the list looks long, it won’t take much effort to round them up. The lists below will help you keep track. Your loan officer will also indicate which items will not be needed and also help you prioritize which items to send in first.
- Name of current employer, phone and street address
- Length of time at current employer
- Salary including overtime, bonuses or commissions
- Two years of W-2s
- Profit & Loss statement if self-employed
- Pensions, Social Security
- Public assistance
- Child support
- Bank accounts (savings, checking, brokerage accounts)
- Real property
- Investments (stocks, bonds, retirement accounts)
- Proceeds from sale of current home
- Gifted funds from relatives (e.g. down payment gift for FHA loan)
- Current mortgage
- Child support
- Car loans
- Credit cards
- Real property
Your real estate agent will be able to grab some of the harder-to-find items such as property taxes.
- Street address
- Expected sales price
- Type of home (single family residence, condo, etc.)
- Size of property
- Real estate taxes (annual)
- Homeowner’s association dues (HOA)
- Estimated closing date
Be prepared to explain any missteps in your financial background. It’s good to have dates, amounts and causes for any of the following:
Type of Mortgage
- Fixed or adjustable
- Forward or reverse
- Government insured: VA, FHA, USDA
VA Certificate of Eligibility (COE)
If you are applying for a VA loan you will need proof of your military service. The VA can provide a Certificate of Eligibility (COE). Your lender will be able to pull it for you. If you want to get it yourself, you can do so via the eBenefits website.
All the documentation from above is pulled together to produce the Loan Estimate. The Loan Estimate describes the terms and predicts the costs associated with your loan. By law, you must receive it within three days of your application.
The Loan Estimate includes closing costs, the interest rate and monthly payments (principal, interest, taxes and insurance). A notification is included if interest rates can change in the future, as would be the case with Adjustable Rate Loans (ARMs). It also includes information about any special features such as pre-payment penalties or if the loan balance can ever increase in spite of you paying on time (called negative amortization).
At this stage, you’re not yet approved nor denied a loan. A loan estimate is simply a statement of the terms and estimated fees in plain English. It’s like getting an estimate for car repairs; no one has picked up a wrench yet, you’re just getting a sense of the work that will be done and how much it’ll cost.
Quick note: Most types of loans — but not all — use the Loan Estimate at the application stage. Some loan products, like reverse mortgages, still use two older forms – the Good Faith Estimate (GFE) and Truth-in-Lending (TIL) disclosure.
You can get a sneak peek of what Loan Estimates look like plus an even more detailed explanation of each section of it on the Consumer Financial Protection Bureau (CFPB) website.
4. Loan Processing
Opening the File
Loan processors gather documentation about the borrower and property, review all information in the loan file and assemble an orderly and complete package for the underwriter. They’ll open the file and get the following wheels in motion:
- Order credit report (if not already pulled for a pre-approval)
- Start verifying employment (VOE) and bank deposits (VOD)
- Order property inspection if required
- Order property appraisal
- Order title search
The underwriter is the key decision-maker. They closely evaluate all the documentation prepared by the loan processor in the loan package. They cross check to see if the borrower and property match the eligibility requirements of the loan product for which the borrower applied. For example, for a VA loan, the underwriter will verify the borrower’s military service.
Underwriters review at the borrower’s credit history and their capacity to repay the loan. The collateral (the property) is also weighed into the decision. They verify information and double check for accuracy. They’ll sniff out any red flags that indicate potential fraud.
With everything reviewed, the underwriter approves or rejects the loan. Sometimes underwriters approve the loan with conditions. For example, they might ask for a written explanation of borrower’s credit history, such as late payments or collections.
Lock Interest Rate
At some point after initial approval and before closing, the interest rate for your loan is locked. Interest rates trade up and down every day that bond markets are open for business. You and your loan officer will choose the time to make the commitment.
Title insurance is ordered before the closing meeting so that you can walk away with the keys to your new home, ready to move in. This is also the time to make sure that all the offer contingencies have been satisfied. Once any conditions are satisfied, the closing is scheduled.
Documents (everyone in the mortgage industry calls them loan docs) are drawn, meaning they are printed out and sent to the title company (or attorney’s office) where the closing meeting takes place. You can expect a big stack of papers.
One of the documents worth calling attention to is the Closing Disclosure. It should look somewhat familiar. Think of it as the companion to one the first documents you received in the mortgage loan process, the Loan Estimate. The Loan Estimate gave you the expected costs. The Closing Disclosure confirms those costs. In fact, the two should match pretty closely. Laws prevent them from differing too much.
Three-Day Review Period
You have the right to review the Closing Disclosure three days prior to the closing meeting. This quite period gives you a chance to review all of the terms of the loan. In most cases, you’ll compare the Loan Estimate to the Closing Disclosure but in some cases, you’ll compare the GFE to the HUD-1 Settlement Statement.
At this stage, you’re like a space ship on the launching pad. The countdown has begun. Most of the time, everything goes as planned. Small things in the loan docs are allowed to change, like typos. However, bigger changes reset the three-day review period. Continuing with the space launch metaphor, the “countdown” would start over if:
- The APR on the loan changes by more than 1/8th of a percent (most fixed loans) or 1/4th of a percent (most adjustable rate loans).
- A prepayment penalty is added to the mortgage.
- There’s a change of loan products (e.g. change from a fixed rate loan to an adjustable rate loan).
You have the right to a final walk-through of property 24 hours before your closing meeting. You can make sure the seller has vacated property. You can make sure any contractually stipulated repairs are complete.
The closing is the moment for which you’ve been waiting. It’s time to sign a bunch of documents and complete your purchase or refinance. Some docs seal the deal between you and the lender. Other docs seal the deal between you and the seller (if it’s a purchase transaction).
Please bring two official forms of identification such as a driver’s license and passport to the closing.
If closing costs are not rolled into the loan amount, talk to your loan officer about how you will transfer funds either electronically or via cashier’s check. Closing costs include settlement fees (the cost of doing the loan) plus any prepaid expenses (put in an escrow account) for homeowner’s insurance, mortgage insurance and taxes.
A checkbook will come in handy for any small differences in the estimated balance owed and the final amount.
The closing meeting will take a couple hours, and there’s a lot of paperwork. Your hand will be tired when it’s all over.
Key Closing Documents
- Closing Disclosure (or HUD-1 and TIL in some cases) – a summary of loan terms, monthly payments and closing costs.
- Promissory Note – as it sounds, it’s the promise that you’ll repay the loan. It shows the loan amount and terms of the loan and the lender’s recourse if you fail to make payments.
- Deed of Trust – secures the note above and gives the lender a claim against the home if you fail to live up to the terms.
- Certificate of Occupancy – if the house is newly constructed, this is the legal document you’ll need to move in.
TIP: Be sure to read all documents. And ask questions! Lastly, don’t sign any forms with blank lines or space.
When everything is signed, your participation in the closing meeting is done. Congrats! The very last closing items happen in the background; the title company will complete the recording and funding.
Right of Rescission
Federal law provides an opt-out or cancellation of some types of mortgage transactions called a Right of Rescission. You have until midnight of the third business day after signing the closing docs to rescind (cancel) the following:
- A refinance transaction on an owner-occupied home
- Reverse mortgages
Purchase transactions do not have this feature.
There you have it, the six distinct phases of the mortgage loan process! Hopefully, you feel a little more educated about each step and feel more comfortable about what to expect along the way.