This step involves having a lender, housing counselor, or real estate professional calculate how much you may be able to borrow for a home. This estimate is based upon the household’s income and debts.

Pre-qualifying for a loan is not the same thing as applying for a loan or receiving approval for a loan. It is not a guarantee that you will be approved for the loan amount that is determined. It is simply a good estimate of the maximum size loan for which you may be approved.

Pre-Approval

This step involves applying for a loan and obtaining approval for a maximum loan amount before completing a purchase agreement on a home. Pre-approval usually has a time limit.

One of the first questions a lender will consider is how much of your total income you will spend on housing. This information helps the lender decide whether you can comfortably afford a home. When you are qualifying for a loan, a lender will use your gross income. That means that all the money you earn before taxes, including overtime, commissions, dividends and any other sources—as long as you can show a steady history for the sources.

Your monthly housing expense as a percentage of your monthly income is called the housing expense ratio. A good goal is to spend in the range of 25% to 33% of your income on your house payment (including the mortgage, property taxes,
mortgage insurance and hazard insurance).

One important thing your lender will do is compare your housing expenses now to the expense you’ll have if you buy a home. The smaller the increase, the stronger your application looks. 

In addition to your income, a lender will look at your debts. Generally, debts include your house payment as well as payments on all loans, charge cards, child support, etc. that you make each month. The percentage of debts to income is called the debt-to-income ratio. A good goal is to spend about 36%-38% of your income on all debts.