By Kim P Wondering whether you need a "mortgage commitment letter"? We explain what it is and why it could give you an edge over other home buyers. Certain terms in the mortgage industry sound alike but are completely different. For instance, pre-qualification, pre-approval, and mortgage commitment all sound similar. But these three terms - which describe three different types of letters you can get from a lender - mean different things.
We explain why a mortgage commitment letter is the top letter to get and how it's different than the others.
THREE TYPES OF APPROVAL
Lenders usually provide one of three types of approval:
Pre-qualification letter
Pre-approval letter
Mortgage commitment letter
They all provide some type of approval, but some hold more merit than others. PRE-QUALIFICATION LETTER This is the loosest OK from a lender, indicating that they may possibly grant you a mortgage. It may come in the form of a letter or a verbal agreement. The lender probably talked to you about your income, assets, and credit, but did not verify anything you told them. They used the numbers you provided to give you an estimate of what you could afford. View this as something to go by as you begin home shopping, but nothing said or written here is set in stone. PRE-APPROVAL LETTER A pre-approval letter is a step up from a pre-qualification. Realtors and sellers will take a pre-approval letter seriously. It shows them that a lender actually evaluated your financial documents and determined your eligibility for a loan. It has a dollar amount and some assurance that a lender believes in your ability to afford a mortgage. Oftentimes the letter includes conditions you must satisfy to close on the specified loan. Related: Pre-Approval Mortgage - Learn the importance of the pre-approval step and how to make the most of it. MORTGAGE COMMITMENT LETTER
Generally, you won't get a mortgage commitment letter until you sign a sales contract. The underwriter will do more than approve your credit history and financial documents. There must be a specific property you intend to purchase, and they'll want to see the results of an appraisal and the title search. They also want to confirm that there aren't any liens on the home and that the current owners have the right to sell the home. The letter states the approved loan amount for the specific address shown and may include some conditions before you can actually sign on the dotted line.
STEPS TO OBTAIN THE MORTGAGE COMMITMENT LETTER
Think of the process of obtaining the mortgage commitment letter like a ladder. You take one step at a time.
Fill out a mortgage application. On this application, known as the 1003, you disclose your personal information. The lender needs your social security number, address, and birthdate. They also need the amount of your current income, debts, and assets.
Give permission to pull your credit report. The lender uses your credit score and payment history to determine your risk level. Certain loan programs have minimum credit scores in order to qualify too.
Provide the lender with your financial documents. This usually means 2 paystubs, 2 years' worth of W-2s or tax returns, and 2 months' worth of asset statements. The loan officer evaluates your documents. He may also input your information into an automated underwriting system for your desired program.
These steps are all it takes to obtain the pre-approval letter. With conditional approval, you have qualified for a specific loan amount. Your approval depends on the property's value and condition. If they change before you sign a sales contract, your deal with the lender could fall through. Shopping for a home with a pre-approval letter is easier than with just a pre-qualification.
More doors will open to you with the pre-approval letter in hand (some realtors won't consider your bid if you don't have one). At this point, you don't need the mortgage commitment letter whover it can give you an advantage having one, but you can start the process.
Your loan officer will probably send your file to the underwriter while you shop for a home. As it sits in the queue, you look for appropriate homes within your price range. You can submit a bid and sign a sales contract with just the pre-approval. Your attorney will likely encourage you to include a financing contingency in the contract. This gives you a way out if your financing falls through.
Tip: A financing contingency gives you time to secure financing. The seller usually wants the commitment by a certain date. Sellers often stop marketing their home once you sign a contract, but they'll jump back into promoting their property if you can't meet their deadline. You have until the specified date to provide the mortgage commitment letter. If you can't, you or the seller may be able to back out of the contract without penalty.
After a review of your application, credit report, and documents, the underwriter may need more information. These conditions pertain to your financial life. Some common items include:
Proof of paid collections
An executed gift letter from donors providing you with down payment money
Verification of your employment
A letter of explanation for any late payments on your credit report
Underwriters also don't take your documents at face value. Instead, they look for issues. Here are a few examples of what they may spot:
Your paystubs don't provide enough information
Your tax returns have inconsistencies in them
You have large deposits in your bank account without proof of their origination
There are late payments or collections on your credit report
Any inefficiencies the underwriter spots usually become a condition.
The lender usually does not provide the mortgage commitment letter until two things happen:
You have an executed sales contract signed by all parties
The lender has the appraisal for the specific property
The underwriter needs the contract and appraisal to provide the commitment letter. Because the commitment is an agreement to provide a loan, the lender needs to make sure everything is in place. The appraisal shows the condition of the property as well as its value. Both factors play a role in the lender's ability to fund a loan.
CONDITIONS ON THE MORTGAGE COMMITMENT LETTER
Typically, lenders provide mortgage commitment letters with a few conditions. At this point the underwriter knows you can financially afford the loan - but they need to confirm that the value of it is solid. They'll want to tie up some loose ends in your file, such as:
Provide proof of purchase of a homeowners policy for your new home with at least the next 12 months' premium paid
Clear title
Obtain a flood certification with proof of necessary flood insurance if the home is in a flood zone, with at least the next 12 months' premium paid
Any conditions that aren't met will prevent you from closing on the loan. THE CONTENTS OF THE MORTGAGE INSURANCE LETTER The mortgage commitment letter contains everything you and your seller need to know about the loan. It usually contains the following information:
Names of all parties (borrowers and lender)
Type of loan (FHA, VA, USDA, conventional, or non-conforming)
Loan number
Address of the contracted property
Agreed upon loan amount
Agreed upon term
Interest rate (if locked in)
Date of lock expiration for interest rate
Amount of origination points lender charges
Estimated monthly payment, sometimes broken down into principal, interest, taxes, and insurance
List of events that could change the approval, such as change in employment, income, or debts
THE BOTTOM LINE
Shopping for a home occurs in several phases. Waiting until you have a pre-approval from a lender takes the stress out of the situation. Knowing what you can afford helps you stay targeted in your search for a home. Once you find a home, you must act fast, though. Sellers usually give you a few weeks to obtain the mortgage commitment letter. Having the pre-approval helps speed up the process. The lender just needs to wait for the appraisal and title to approve you for the loan on the contracted home.
The mortgage commitment letter does not mean you are "clear to close." It may have conditions you must satisfy. It is a step above the pre-approval, though, as it shows the lenders commitment in lending you the funds. Once there are no more conditions, you can close on the loan and take possession of your new home.