A mortgage preapproval is a written statement from a lender affirming that you've qualified for a home loan under specific terms. With a preapproval, the lender pulls your credit report and examines your documents, so be prepared to provide details about your income, debt, and financial accounts.
Read on to learn more about how to get preapproved for a mortgage.
How To Get Preapproved for a Home Loan
A mortgage preapproval letter says how much that lender is willing to lend to you. In other words, you will know how much house you can afford, making your house hunting process easier for you and your real estate agent. Bear in mind that the letter may have an expiration date (typically 30 to 60 days).
Before you get a mortgage preapproval, it's best to familiarize yourself with some key terms, such as how a prequalification differs from a preapproval.
Other necessary steps include reviewing your finances, gathering all your essential documents and shopping for lenders.
Understand the difference between prequalification and preapproval
Both "mortgage prequalification" and "mortgage preapproval" are two key steps in the mortgage application process. Some people use the terms interchangeably, but there are significant differences that you should understand.
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. On the other hand, a mortgage preapproval carries more weight because it's a more comprehensive application process (more on that below).
|The lender reviews information, including income and employment history||No paperwork|
|Requires a credit history check||No credit check|
|It tells how much you can borrow||Gives you an estimate of what you can borrow|
|Sellers frequently require it before accepting your offer||Helpful if your financial situation will change in the future|
"Sellers would prefer to see a preapproval letter from the lender to know this is a [serious] buyer over a prequalified buyer," said Nancy Newquist-Nolan, a real estate agent at Coldwell Banker in Santa Barbara, California.
A prequalification can be helpful, though, if you're just dipping your toes into the mortgage waters. The process will give you an idea of what size mortgage you may qualify for and help you narrow down the search for your new home.
Prequalification may also be worthwhile if your financial situation will change shortly — say, because you're looking for a new job.
Review your finances
To avoid surprises, take a close look at your household income, monthly expenses, investment bank 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.
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.
Other factors that affect your preapproval include:
Credit history and FICO score
Your credit history is one of the most important factors for getting a mortgage, and there are two major consumer credit scoring companies, FICO and Vantage Score.
|Type of Loan||Minimum Credit Score|
|FHA loan with 3.5% down payment||580|
|FHA loan with 10% down payment||500|
|VHA Loan||None, but 620 is preferred|
|USDA Loan||None, but 420 is preferred|
You don't need a perfect credit score to buy a house, but those with outstanding scores are usually rewarded with lower interest rates and a greater variety of payment options. Buyers with very poor credit have the option of finding a co-signer who has better credit than them to help secure the loan.
Self-employed individuals tend to have a more challenging time getting preapproved. Besides meeting standard loan requirements, they have to prove their line of work or small-business ownership. Only borrowers who have an ownership interest of 25% or more in a business and are not W-2 employees are considered "self-employed."
However, there is an exception if the borrower can show a two-year history in a similar line of work, including documentation that proves an equal or higher income in the new role compared to the W2 position.
The debt-to-income ratio is the percentage of your monthly gross income that goes toward paying debts. Lenders will consider two types of DTI during the mortgage process: front-end and back-end. The first consists only of your housing-related expenses, whereas the latter also includes all your minimum required monthly debts.
The lower your DTI, the better your chances of securing a home loan. Anything over 50% is considered unacceptable, but keep in mind that the specific DTI requirements will vary depending on the type of loan you're getting.
For example, FHA loans secured by the government have more lenient requirements — you can have a DTI of up to 57% and still get approved for an FHA home loan. USDA loans used to buy homes in rural areas have a lower maximum DTI of 41%.
The loan-to-value ratio (LTV) is a number lenders use to determine how much risk they are taking on a loan to a potential borrower. It measures the relationship between the loan amount and the market value of the property you want to buy, and it can also determine whether mortgage insurance will be required.
All mortgages have a maximum LTV to qualify. However, like with DTI, the LTV varies depending on the loan. FHA loans, for example, have an LTV of 96.5% since they allow down payments of as little as 3.4%.
Put your documents together
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.
When you're getting a mortgage when self-employed, be prepared to provide a two-year history of earnings to show lenders your long-term averages.
If you have your paperwork in order, you can get preapproved quickly. Many mortgage lenders offer preapproval to buyers within 24 hours of a mortgage application submission. Some online-only lenders, such as Quicken Loans and Better Mortgage, say they provide 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.
Other documents you should check off your preapproval checklist are:
- A driver's license or U.S. passport
- A Social Security number or card. If not a U.S. citizen, a copy of the front and back of your green card(s)
- Verification of employment
- Copy of their credit reports from the three national credit bureaus
- Recent pay stubs covering the last 30 days
- W-2 forms from the previous two years
- Proof of any additional income
- Last two years of personal federal income tax returns with all pages and schedules. If self-employed, last two years of individual federal income tax returns with all pages and schedules, as well as a business license, a year-to-date profit and loss statement (P&L), a balance sheet, and a signed CPA letter stating you are still in business
- Bank statements proving that you have enough to cover the down payment and closing costs. If someone is helping you with the down payment, a gift letter stating that the fund is a gift and not an IOU
- Last quarterly statements for asset accounts (401(k), IRA, stock accounts, mutual funds)
Find the best mortgage lender
Todd Sheinin, chief operating officer at Homespire Mortgage, a lender in Gaithersburg, MD, recommends applying for mortgage preapproval with 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. Some types of loans are designed for low-income homebuyers or first-time homebuyers. VA Loans typically require no down payment.
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 significant savings.
According to the Consumer Financial Protection Bureau, rates offered to a borrower with good credit on a 30-year fixed conventional mortgage can vary by more than half a percent.
Fill out your application
Next up, you'll fill out a mortgage application. This application includes your Social Security number and identifying information so that the mortgage lender can run a credit check.
A credit check to qualify for a mortgage counts as a hard credit inquiry, but if you're shopping lenders within a 45-day time span, the combined checks would count as a single credit pull.
A sample mortgage application may look like this:
- Mortgage type and loan terms - The mortgage type you're applying for, the loan term and amount, amortization and interest rate.
- Property information and loan purpose - The property address, legal description, and year it was built, loan type (purchase, refinance, new construction) and type of residence (primary, secondary or investment)
- Borrower information - This includes your full name, Social Security Number, date of birth, marital status, dependents, address history and years of school attended.
- Employment information - The information from past and current employers, including employment dates, job title and monthly income.
- Monthly income - The information on your monthly income, including overtime, bonuses and commissions, and child support or alimony, if applicable.
- Assets and liabilities - A record of all checking and savings accounts with up-to-date balances, retirement savings, life insurance policies, and mutual funds accounts. The list of liabilities includes outstanding debts such as car payments, student loan payments and child support.
- Transaction details - Includes loan amount, purchase price, closing costs, mortgage insurance, etc.
- Declarations - You'll have to disclose past bankruptcies or foreclosures, pending lawsuits or delinquent debts. Here you'll specify if you're a U.S. citizen or permanent resident.
What Happens After Preapproval?
After getting preapproved for your home loan, you can officially start house hunting as you'll have a better idea of your price range. If you find a home, you can talk to your lender to lock in your rate, bid on your new home and sign a purchase agreement — which is the last step before going to your lender to complete the process.
Remember to keep your finances in check during this process.
Maintain your financial health
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.
There are some mistakes you'll want to avoid making after getting a 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 improve your credit.
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.
Lock in your mortgage 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 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. Here's some information on current mortgage rates.
Bid for your new home
Ready to make an offer on a home? Getting a custom preapproval letter from your lender lets the seller know you are a serious buyer.
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.
Being self-employed or having issues such as a low credit score previous, previous foreclosures, and outstanding debt can elongate the process.
Summary of Money’s Guide for Mortgage Preapproval
The mortgage preapproval process will help get your documents and finances in better shape and make the entire closing process faster. It will also help you understand how much house you can afford and make you more attractive to sellers.
To get a preapproval letter, you'll need to provide your lender with the necessary documents to verify your employment and financial information.