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How to Get Preapproved for a Mortgage

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How to Get Preapproved for a Mortgage

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A mortgage preapproval is a written statement from a lender affirming 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.

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1 Get approved as early as possible

If you’re starting your homebuying process, a mortgage preapproval letter says how much that lender is willing to lend to you. In other words, you’ll know how much   you can afford, making your house hunting process easier for you and your real estate agent.

Bear in mind the letter may have an expiration date – typically 30 to 60 days.

2 Understand the difference between preapproval and prequalification

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 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. Meaning, the lender is taking your word and, in exchange, giving you a cursory judgment of whether you’ll be approved and for how much.

Preapproval

  • Lender reviews information, including income and employment history
  • Requires a credit history check
  • Shows how much you can actually borrow
  • Required by sellers before accepting your offer

 

Prequalification

  • States the interest rate you qualify for
  • Highlights issues on your credit report
  • Preapproval puts you in a stronger position to negotiate at the dealership because you’re not worried about financing

 

Getting preapproved for a mortgage carries more weight because it’s a more comprehensive application process.

“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 foot into the water. 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.

3 Take stock of your finances

Most lenders determine the mortgage loan amount you can get by applying the 28/36 rule. According to the rule, your monthly mortgage payment, which includes property taxes and homeowners and private mortgage insurance, should be no more than 28% or less of your gross monthly income. You should also only spend 36% of your gross income on all your debts, including your mortgage and other recurring debts, such as a car or student loan payments.

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 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 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.

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 your relationship can’t hurt. 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 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.

5 Shop around for 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 doesn’t mean you’ll be turned down everywhere, but it’s 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.

6 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 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.

7 Maintain financial health

A preapproval letter isn’t a guarantee. The lender can decline to fund the loan if your financial situation or other conditions change before closing. Meaning it’s crucial to avoid extravagant spending and to keep your credit in good shape.

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 because these actions can hurt your credit score. It can take several months or more to mend it later.

If you can help it, don’t make any last-minute job changes requiring an underwriter to verify your new job and income, which could delay your loan’s underwriting and force you to delay closing.

8 Put in a bid

Ready to make an offer on a home? Getting a custom preapproval letter from your lender lets the seller know you’re a serious buyer.

It’ll also give your loan officer a heads-up 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.

Home loans preapproval checklist

  • Driver’s license or U.S. passport
  • 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 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’re still in business
  • Bank account statements proving you have enough to cover the down payment and closing costs. If someone is helping you with the down payment, a gift letter stating the fund is a gift and not an IOU
  • Last quarterly statements for asset accounts (401(k), IRA, stock accounts, mutual funds)

Mortgage preapprovals: What to know

Your income and saving are two key factors lenders will consider during the mortgage process. However, other factors can affect how long preapproval will take and whether or not you’ll be preapproved at all.

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Employment status

Self-employed individuals almost always have a more challenging time getting preapproved. In addition to meeting standard loan requirements, they’re asked to prove their line of work and/or the ownership of their business.

Only borrowers who have an ownership interest of 25% or more in a business and aren’t W-2 employees are considered “self-employed.” However, there’s an exception if the borrower can show a two-year history in a similar line of work, which includes having documentation proving an equal or higher income in the new role compared to the W2 position.

Debt-to-income ratio

The debt-to-income ratio is the percentage of your monthly gross income that goes toward paying debts. There are two types of DTI lenders will consider 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 by lenders, but keep in mind 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%.

Loan-to-value ratio

The loan-to-value ratio (LTV) is a number lenders use to determine how risky a loan to a potential borrower might be. 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, just 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%.

Going for an LTV of 80% or less is ideal because you get unique benefits as a buyer, but requiring a down payment of 20%. Ultimately, each buyer will need to figure out their own LTV based on how large a down payment they can afford

Credit history and FICO score

Your credit history is one of the most important factors when it comes to getting a mortgage.

Type of Loan and minimum credit score

  • Conventional loan – 620
  • Jumbo loan – 680
  • FHA loan with 3.5% down payment – 580
  • FHA loan with 10 down payment – 500
  • VHA loan – None, but 620 is a 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.

Why getting preapproved is such a big deal

Getting preapproved for a mortgage helps you shop for homes you can afford and shows you’re a serious buyer.

But a letter of preapproval is more than just a way to look good to sellers. It also helps you find the right mortgage lender and provides some flexibility in bargaining or negotiating for a better price range or specific costs, repairs and improvements to a home.

Getting preapproved makes the entire closing process faster, too. It takes an average of 50 days to close on a house, and part of that period is due to the process of mortgage approval.