Your home is likely to be one of the biggest purchases of your life — and you’ll probably need a loan to make it happen. Getting a mortgage preapproval can give you an advantage while house hunting, and it’s almost a rite of passage as you go through the process of buying a home.
By going through the preapproval process, you can show sellers that a lender has already vetted you and will lend you money. The steps for getting preapproved for a home loan include sharing detailed financial information about your income and debt, and undergoing a credit check. Once you’re approved, though, you’ll have a solid estimate that real estate agents and sellers can use to determine whether you’re a serious contender for a home.
What is a mortgage preapproval?
Your mortgage preapproval is a statement of how much money a lender is willing to let you borrow to pay for a house. It’s an important step in the home-buying process. A preapproval is based on your financial situation, including how much you have in bank and investment accounts and your income, as well as your financial obligations, or what you owe. A lender also performs a hard credit inquiry when determining preapproval for a home loan.
With all of that, the lender can make a fairly informed estimate about how much house you can afford. Your mortgage preapproval is a document that states that the lender is prepared to move forward with the loan, as long as the home meets certain qualifications and your financial situation doesn’t undergo a big change in the following weeks.
Why should I get preapproved?
Once you’re preapproved, sellers (and their real estate agents) know you’re serious about a home — and they know you can afford it. With a preapproval letter in hand, you can show that a bank has already agreed to issue the mortgage. If you look interested in a home and want to make an offer, the seller wants to know that you can follow through. Without a preapproval, you could be passed over in favor of someone who already has a lender and the funds lined up.
On top of that, getting preapproved gives you an idea of how much home you can afford. You can see how much money the lender will give you, figure out a down payment, and know if the houses you’re considering are practical. It saves time during house hunting to immediately eliminate homes out of your price range.
How to get preapproved for a mortgage
First of all, understand that, because of the large amount of money involved in a real estate transaction, you’ll need documentation proving your income and assets. Some of the documents you’ll need to submit to your lender include:
- Current pay stubs
- Federal income tax returns from the last two years (including W-2s)
- Recent bank statements
- Investment account statements
- Identifying documentation, such as a driver’s license or passport
Those who are self-employed might also need to include information from business accounts and undergo an income audit. This might include asking an accountant to verify that your income is stable by speaking with customers, reviewing business records and taking other steps. Find out from your lending institution what’s required when you’re self-employed.
In addition to providing documentation, you also have to agree to a credit check. The lender will perform a hard inquiry, which can impact your credit score.
Before applying for mortgage preapproval, check your credit report. You’re entitled to a free copy from each of the major credit bureaus once every 12 months. Obtain your report at www.annualcreditreport.com and review the information for mistakes. Errors can impact your credit score, bringing it down, and this can impact whether you’re approved, as well as whether you qualify for the best mortgage rates.
Lenders use the information in your credit report to assess your credit utilization, or the amount of credit you’re using relative to your total credit limit. The lower your credit utilization is, the better your chances of getting preapproved. Many lenders prefer to use the so-called “28/36” qualifying ratio to figure out what monthly payment you can afford. In general, they like to see a mortgage payment taking up no more than 28 percent of your gross monthly income, and your total debt payments (which includes credit cards, car loans and other debt in addition to your mortgage) accounting for no more than 36 percent of your gross monthly income.
It’s also important to note that, if you’re getting a conventional mortgage, you usually need a credit score of at least 620 to qualify for a mortgage. You might be able to get a mortgage preapproval with a lower score, and there are programs, like FHA loans, that allow lower scores, but the higher your score, the lower your interest rate.
How long does it take to get preapproved?
Depending on the situation, and your finances, it can take up to a few days to receive your mortgage preapproval. If you have to wait for an income audit, though, it can take a couple of weeks to receive your preapproval letter. If you have everything in order, and your credit looks good, though, it’s possible to get preapproval for a home loan within one business day in some cases.
Preapproval vs. prequalification
It’s important to understand the difference between preapproval vs. prequalification.
With a prequalification, you’re often subject to a soft credit inquiry, just to get a feel for your situation. Additionally, the lender often relies on your own representation of your financial situation, rather than requiring documentation. A prequalification is an indication of what you likely qualify for, based on the information you give and the results of a less-invasive credit check. While a prequalification can be useful when shopping around and comparing potential loan terms, it’s not usually taken seriously by sellers and real estate agents.
On the other hand, a mortgage preapproval is a more rigorous process. You provide documentation to back up your claims and the lender reviews your credit report in more depth to get a feel for your debt-to-income ratio and other information to help them make a determination. Because a preapproval is backed up with data, it’s accepted as proof that you can afford the home you’re looking at and the bank will fund your loan.
Whether you’re buying your first home, or you’re a house-hunting veteran, getting a mortgage preapproval on a home loan is a smart move if you want to remain competitive as a home buyer. Your mortgage preapproval shows that a bank is ready to lend you a certain amount of money, making an offer you put on a home a “serious” offer. While it can feel burdensome to go through the documentation steps required to get preapproved, it can actually save time and hassle in the long run.
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