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Ready to get serious about buying a home? Get preapproved for a mortgage.
In a nutshell, a mortgage preapproval letter is a written statement from a lender affirming that you’ve qualified for a home loan and specifying how much money the lender will allow you to borrow. Historically, sellers have preferred offers that include such a letter, but many have begun requiring that buyers get preapproved before even taking a tour.
“The letter is a stamp of approval that says to a seller, ‘You can trust in my ability to finance this purchase and close on it,’” says Todd Sheinin, chief operating officer at Homespire Mortgage, a lender in Gaithersburg, MD.
From the documents you’ll need to how long it lasts, here’s everything you need to know about how to get preapproved for a home loan:
1. Start early
Getting preapproved shows you how much house you can actually buy, which allows you to set a budget and avoid wasting time looking at homes you can’t afford. “The worst thing that can happen is you fall in love with a home and then you go and apply for a loan and find out you can’t afford that home, or that you can’t qualify for a mortgage at all,” says Sheinin. “So you want to get preapproved as early as possible.”
2. Decide if you need to be preapproved vs prequalified
Some buyers mistakenly use the terms “mortgage prequalification” and “mortgage preapproval” interchangeably.
Prequalification, or “prequal,” is a cursory overview of your income, assets, debt, and credit by a lender—but you don’t have to provide any paperwork. In other words, the lender is taking your word and in exchange giving you a cursory judgement of whether you’ll be approved and for how much.
Getting preapproved for a mortgage carries more weight because it’s a more comprehensive application process (more on that below). “Sellers would prefer to see a preapproval letter from the lender to know this is a [serious] buyer, over a prequalified buyer,” says Nancy Newquist-Nolan, a real estate agent at Coldwell Banker in Santa Barbara, Calif. Sheinin agrees. “If you just have a prequalification, you’re going to get left in the dust when going up against buyers who’ve been preapproved,” he says.
Prequalification can be helpful, though, if you’re just dipping your foot into the water. The process will give you an idea of what size mortgage you may qualify for and help you narrow down your home search. prequalification may also be worthwhile if your financial situation is going to change in the near future—say, because you’re looking for a new job.
3. Take stock of your finances
It’s the question on every buyer’s mind: How much house can I afford? If you’re taking out a mortgage—versus paying all cash—the answer boils down to what size loan you can get.
Many lenders determine what that magic number is by applying the 28/36 rule. This says that your mortgage payment (which includes property taxes and homeowners insurance) should be no more than 28% of your gross income, and your total debt (including your mortgage and other recurring debts, such as car or student loan payments) should be no more than 36% of your gross income.
For example, if you earn $3,500 a month pretax, your monthly mortgage payment should be no higher than $980, which would be 28% of your monthly income. Some lenders may let you borrow more, but experts say it’s best to avoid taking on a larger payment, so that you don’t stretch your finances too thin and risk falling behind on your mortgage.
To avoid surprises, take a close look at your household income, monthly expenses, investment accounts, and credit score before applying for preapproval. You’re entitled to a free copy of your report from each of the three major credit bureaus—Equifax, Experian, and TransUnion—at AnnualCreditReport.com. Check your credit report for errors—one in four Americans said they spotted errors on their reports in a 2013 Federal Trade Commission survey—and alert your creditor immediately if you spot a mistake.
This process will also help you determine how much you’re comfortable spending each month, which may be less than what a lender will offer, and how large a down payment you can make.
4. Gather your documents
To determine your eligibility for a mortgage, a lender will want to see your pay stubs, tax returns, W-2 forms, and proof of funds for your down payment. A lender will also do a hard credit check, which will have a small impact on your credit score.
If you’re self-employed, be prepared to provide a two-year history of earnings to show lenders your long-term averages. And if you have a couple of steady paying clients that are the anchor of your business, letters affirming that relationship can’t hurt.
If you have your paperwork in order, you can get preapproved quickly. A number of mortgage lenders offer preapproval to buyers within 24 hours of an application submission. Some online-only lenders, such as Quicken Loans and Better Mortgage, say they offer preapproval in minutes. preapproval letters are typically valid for 60 to 90 days. Most lenders will allow you to get an extension, but you may need to resubmit some documents.
Most lenders offer mortgage preapproval for free, in the hope of earning your business. Lenders that do take an application fee for preapproval typically charge from $300 to $400, but the money is often credited toward your closing costs if you move forward with the lender.
4. Shop around
Sheinin recommends applying for mortgage preapproval to at least three lenders. (Don’t worry, your credit score will only be hit once.) If you’re denied a loan, find out why and then take steps to address the issue. You may need to pay off credit card debt or buff up your down payment funds to get preapproved. A no from one lender does not mean you’ll be turned down everywhere, but it is often a sign your finances need some work and you may not qualify for the best loan terms. Lender shopping can also lead to big savings. Rates offered to a borrower with good credit on a 30-year fixed conventional mortgage can vary by more than half a percent, according to the Consumer Financial Protection Bureau.
5. Consider locking in your rate
Usually, you can apply for what’s called a mortgage “rate lock”—a guarantee from a lender to honor a specified interest rate for a set period (typically, 60 to 90 days)—once a seller accepts your offer. Some lenders, though, will let you lock in a rate once you’ve been preapproved—although you may need to pay a fee to extend the rate lock if it expires before you buy a home.
6. Don’t blow it
A preapproval letter is not a guarantee. The lender can decline to fund the loan if your financial situation or other conditions change before closing. That means it is important to avoid extravagant spending and to keep your credit in good shape. There are some mistakes you’ll want to avoid making after getting mortgage preapproval: don’t apply for new lines of credit, make large credit purchases, miss any credit card payments, or co-sign a loan for others—these actions can hurt your credit score, and it can take several months, or more, to mend your credit.
And, if you can help it, don’t make any last-minute job changes that would require an underwriter to verify your new job and income, which could delay your loan’s underwriting and force you to delay closing.
Ready to make an offer on a home? Getting a custom preapproval letter from your lender that states the property address and that you’ve been preapproved for the specific amount that you’re offering will show the seller that you’re serious about their house. It will also give your loan officer a head’s up that you may sign a purchase agreement soon, which can help them prepare for the next steps in the mortgage approval process, such as arranging a home appraisal.