SANTA CRUZ (May 22, 2010) - One of the most important steps towards becoming a homeowner is to meet with a mortgage professional in order to get your loan pre-approved before you even start looking for a home. It is called a pre-approval because you have not identified the property and therefore, there is no appraisal, purchase contract or preliminary title report yet. For the pre-approval, your lender will want to review your tax returns, W-2s, paystubs, bank statements and credit report. This documentation will provide the information needed for an underwriter to determine what size mortgage you will be able to obtain.

Once your income, assets and credit history are input into the computer along with a proposed sales price, loan amount and interest rate, it is software that is provided by Freddie Mac and Fannie Mae that determines whether your loan is approved or denied. This process is called automated underwriting and is used by lenders throughout the United States to determine whether or not the loan will be acceptable to either Freddie Mac or Fannie Mae.

If the initial loan request is denied, there is still hope. For example, lowering the loan amount or interest rate may give us the approval we are seeking. Reserves, which is the cash left over after the purchase is complete, often plays an important part in the loan approval process. The more cash, the more likely to get an approval. Gifts and/or retirement accounts may be included to boost the borrower’s cash reserves.

Unfortunately, since Freddie Mac and Fannie Mae are constantly tweaking the automated underwriting software, an approval today could become a denial tomorrow. For example, as recently as last year we were able to get loan approvals with debt-to-income ratios as high as 65 percent; however, today that maximum is is 45 - 50 percent. Minimum credit scores have risen also. A borrower with a score of 600 last year worked but this year the minimum score is 620. By the way, credit scores can sometimes be improved by simply paying down outstanding balances on credit cards. Consult with your mortgage professional for details.

Because loan approvals are in this fluid state, it is imperative to constantly be updating them. A borrower that had a loan pre-approved in March and is now ready to make an offer in May is well advised to have his or her approval updated. Furthermore, a borrower that was pre-approved for a mortgage in March will need to have the underwriter review updated paystubs and bank statements as well as an updated credit report to be sure no new purchases have been made and no payments have been paid late since the last loan approval.

This column is written every Saturday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 of email him at Peter@SantaCruzHomeFinance.com.