How to Get Pre-Approved for a Mortgage
Are you ready to house hunt, but are wondering "How much mortgage can I afford?" Getting pre-approved for a mortgage can show sellers that you are a serious prospect and give you a leg up on other buyers who jump the gun by visiting open houses without even knowing their budget. In this market, where sellers are getting many offers including cash offers, a pre-approval can help you stand out as a buyer. When you have a documented pre-approval, the seller knows you will be able to get the funding you are offering for the home and you’ll be able to close more quickly and reliably.
What is a Mortgage Pre-Approval?
When you get pre-approved for a mortgage, you literally go through the mortgage application process. The lender will want you to supply documentation of your employment, income and assets and consent to a credit check. Keep in mind that what you will need to provide in terms of documentation will depend on the lender. However, in general, the more you provide upfront, the more concise and accurate your approval will be. Your information will be checked and verified and the amount you qualify to borrow will be verified as well.
At the end of the pre-approval process, you’ll receive a letter that you can take with you as you shop for a home. This pre-approval letter can be presented to sellers along with your offer, confirming that you are ready to buy. This can accelerate your home buying experience since you’ll be all ready to move forward with your offer as soon as you find your dream home.
Once you find the home you want and it is within the purchase price approved by your lender, you can lock in your mortgage interest rate while you finish the home purchase and loan funding process. This means that if interest rates rise, you’ll still get the lower quoted rate. If interest rates drop after you have locked, you might be able to request the lower interest rate, but there is typically a fee involved. Getting pre-approved helps streamline all of the following steps when purchasing your home.
The Difference Between Pre-Approval and Pre-Qualification
Many lenders offer the option to “pre-qualify,” but this isn’t comparable to a pre-approval. With a pre-qualification, you supply a bare minimum of information, and you may be permitted to self-report your credit score. Your information is reviewed against an algorithm that estimates how much you could be approved for and can be grossly inaccurate.
The problem with pre-qualification is that there is no verification of your information and no pre-approval letter. Some sellers don’t see a pre-qualification as beneficial, as your mortgage applications could turn up all sorts of problems that could disqualify you just as easily.
Nothing feels worse than putting an offer on a home and then having your loan application ultimately denied because you didn’t know about some pesky credit problems or you underestimated your home loan costs and don’t have enough for your down payment.
By getting pre-approved, you show that you’re serious about home shopping. Since you’ve already been vetted and found to be worthy of a home loan, a seller will be more likely to put you at the top of their negotiations list than someone with just a pre-qualification.
How to Get Pre-Approved for a Mortgage
There are several steps to the pre-approval process. Before starting your mortgage application, review the following and gather all of your documentation.
Proof of Identity
To get the process started, your mortgage loan officer will need to verify your identity and pull your credit report. This process can usually be done online by filling out required loan forms or via telephone with your mortgage loan officer.
It’s typically a good idea to check your credit history a few months in advance of applying for a home loan, so you can learn your credit score and dispute any inaccurate information. You can obtain your credit report at annualcreditreport.com and are entitled to one free report a year. Once you have ordered your credit report, be sure to review it for errors (read our “What is a Good Credit Score?” article to learn more). Once you’ve done this, leave your credit alone and don’t make any big purchases or open new credit accounts until your home purchase is complete.
Proof of Assets
You’ll need to provide documentation of your assets, including cash held in checking and savings accounts. This will help verify that you have enough to cover your down payment, appraisals and inspections, the purchase of mortgage discount points if desired, any lender fees, and other closing costs. Your most recent bank statements will typically suffice and may be used to help prove both income and assets.
Proof of Income
Even with a small down payment or less than stellar credit, you may still get pre-approved for a home loan as long as the lender believes you can consistently make your monthly mortgage payments. Your most recent paystubs plus your past two years of tax returns and two years W2, if not self-employed, can help certify your income and help the lender determine how much mortgage you can afford.
Proof of Employment
In addition to your current paystubs, the lender will likely request a verification of employment directly from your employer, a couple days before closing. If you are self-employed, a letter from your accountant may suffice, but you’ll also need to provide business tax returns and a profit and loss statement. If you aren’t employed, you’ll need to be able to show substantial, regular income from another source.
Proof of Credit-Worthiness
While you don’t have to display perfect credit to get pre-approved for a mortgage, the higher your score is the less interest you’ll typically pay. If your score is low, you may qualify for a loan backed by the Federal Housing Authority (FHA.) These also offer a lower down payment than the conventional 20%, but typically require you to carry private mortgage insurance (PMI.)
After checking your credit, your lender will explain how high your mortgage limit is, which types of mortgage loans you can apply for and what your down payment and interest rates will look like.
How Lenders Calculate Your Borrowing Limit
In addition to evaluating the factors listed above, your lender will consider two other key ratios when determining how large of a mortgage to approve.
Your debt-to-income (DTI) ratio compares your monthly debts to your monthly income. Your debts can include auto and student loans, revolving charge accounts, other lines of credit and your estimated mortgage payment. These are added then divided by your gross monthly income. The resulting percentage is your DTI ratio. Typically, lenders want to see a maximum DTI of 43% and prefer borrowers who have a DTI of 36% or less. The higher your DTI is, the more risk is involved with approving you for a mortgage. The lower your DTI is, the more competitive your interest rate may be.
Your loan-to-value (LTV) ratio compares your estimated loan amount to the value of the home you are considering purchasing. The loan amount is divided by the home value, which is determined by a property appraisal. Typically, lenders want to see an LTV no higher than 80%. However, as mentioned previously, there are programs that allow you to put less than 20% down. The higher your LTV is, the higher your down payment needs to be. If you can’t make a down payment of 20% or more, you will probably be required to purchase PMI. This private mortgage insurance helps protect the lender until your LTV decreases.
Getting preapproved helps you know what your home buying budget is well in advance of searching for a home. It can cut down on wasted time visiting open houses outside of your mortgage limit, and it can also prepare you for a strong negotiation stance with potential home sellers.