Getting pre-approval for a mortgage is a good idea, especially if you want to purchase a home in a seller’s market. In a bidding war, a pre-approval letter from a financial institution proves to sellers that you have the finances to back your offer.
When the lender pre-approves you for a mortgage, they confirm that you are a good candidate for a loan based on the information you provided.
What’s the Difference Between Pre-Qualification and Pre-Approval?
Both terms sound similar, but pre-approval is more likely to get a real estate agent and seller to take your home buying search seriously. Some agents may even require you to get pre-approved before showing you potential properties.
What is mortgage pre-qualification?
Although the requirements for this phase vary by lender, pre-qualification enables you and mortgage lenders to assess your financial readiness to buy a home.
In this informal process, your lender asks you to self-report your current income, debt, credit, and assets. This gives them the information they need to determine how much money you can borrow when applying for a mortgage.
They may even run a credit check to help you determine the right mortgage option for your financial situation.
Mortgage pre-qualification is an excellent first step for homebuyers to assess their homeownership readiness. You can get pre-qualified in-person, online, or over the phone. You can find pre-qualification calculators online that allow you to calculate what you can afford by the type of mortgage, such as an FHA loan, adjustable-rate loan (ARM), fixed-rate conventional loan, VA loan, and even a jumbo loan.
What is mortgage pre-approval?
Mortgage pre-approval requires you to provide proof of your financial history. The lender verifies your income, debt, and assets before running a credit check. If you satisfy the requirements, you receive a pre-approval letter that states how much you are approved for and the type of mortgage that has been approved.
Pre-approval is not mortgage approval. You will still have to go through a full mortgage underwriting once you find a home you want to purchase.
How to Get Pre-approved for a Home Loan
If you’ve decided you want to buy a home or upgrade or downsize to a new home, it is advantageous to get a pre-approval letter. This letter demonstrates that you are serious about the process and enables you to focus on homes within your price range. To start the pre-approval process, you need to do the following:
Get your free credit score
Lenders are typically looking for a credit score of at least 620. A score of 740 or more can secure you the best mortgage interest rates. There are numerous options for getting a free credit score. Your financial institution, credit cards, and even online sources can help you find and monitor your score.
Check your credit history
Even if you have an excellent credit score, you should check your credit report for fraudulent activity, delinquent accounts, and errors that may compromise your mortgage application. A credit report details your credit history but not your credit score.
Currently, you are entitled to free weekly online credit reports from TransUnion, Experian, and Equifax. AnnualCreditReport.com is the easiest and quickest way to get them.
The types of errors that you should dispute because they can harm your creditworthiness include:
- Incorrect credit limits and loan balances
- Unfamiliar accounts
- Payments reported as late when you paid on time
- Residences you don’t recognize
- Negative information that is more than seven years old
- An ex-spouse incorrectly listed on a credit card or loan
Determine your debt-to-income ratio (DTI)
Your DTI is another critical tool that lenders use to determine the risk of lending you money and measuring your ability to repay your loan. It is the percentage of your gross monthly income that you pay toward debt, like car loans, credit cards, and student loans.
You will need a DTI of 36% (including your mortgage payment) or less to qualify for a mortgage. However, depending on your other financial information, such as assets, some lenders will accept a higher DTI. But 43% is usually the maximum.
An online DTI calculator can help you determine your percentage and is a good tool for assessing your financial preparedness for applying for a mortgage.
To lower your DTI, create a budget, pay down your debts and avoid taking on more debt.
Gather your financial and personal records
Once you have completed all the groundwork to ensure your finances are in order, you’ll need to gather the information required to prove your income.
Your lender will need the following information from you and a co-borrower if you have one:
- Current address, address history, and personal identification
Mortgage lenders need this personal information to verify your identity and protect themselves against fraud. The lender also requires a government-issued ID with a photo along with your contact information. This can be a driver’s license, ID card, alien registration card, or passport.
Your address history allows them to trace your financial history at each location.
- Social security number
Lenders ask for your social security number so they can see your credit score. Your credit score reflects your ability to repay your loan. They request a Tri-Merge credit report from the three major credit bureaus, TransUnion, Experian, and Equifax. They will then match the information with your social security number to verify that it is correct.
They also review your credit report for collections, tax liens, short sales, bankruptcies, foreclosures, charge-offs, and judgments.
- Employment details
If you have been in your current position for at least two years, lenders need to verify your employment situation. If you have been in your job for less than two years, they may want to confirm the stability of your previous employment.
- Pay stubs
Pay stubs demonstrate that you can afford to buy a home. They also show your base pay and variable income like bonuses, commissions, and overtime. Your lender reviews your pay stubs for any deductions not reported on your credit reports, such as child support or alimony.
- W-2 forms
W-2 forms show your salary received from your employer. Typically lenders request two years of W-2s to verify your compensation.
If you are a contractor or self-employed, your lender will ask for your 1099s to confirm your compensation.
- Bank statements
When lenders look at your bank statements, they want to see that you have enough money to cover your closing costs, downpayment, and mortgage. They also look at your business bank statements if you are self-employed.
- Tax returns
Lenders want the most recent two years of tax returns to check that they match your W-2 and 1099 information. Your tax returns also show income not reported on your W-2 or 1099s. For example, alimony, child support, rental income, and dividends may help you qualify for a mortgage or increase the loan amount.
If you are self-employed, your tax returns, along with your profit and loss statements and balance sheet, help confirm your income and ability to repay a loan. The profit and loss statement and balance sheet are used to show you have not had a drop in revenue.
Your lender also checks to ensure that your filed federal tax returns with an amount due to the IRS have been paid and asks for proof of the cleared payment.
- Investment account statements
Lenders want to see all your income and assets. So you will need to provide your IRAs, 401(k), 401(b), CDs, and stock statements for review.
- A gift letter
A gift letter from the person who gifted you the money assures the lender that the cash in your account is a gift and not a loan. The letter needs to be signed by both the donor and the recipient.
- Monthly debt payments
Your lender also has to determine your DTI, so they will need a list of your monthly debt payments, such as student loans, auto loans, mortgage, and credit card payments.
If you currently have a mortgage, they will need the most recent statement and the insurance policy’s declaration page.
Talk to a Mortgage Lender to Get Pre-Approved
The list of documents required for mortgage pre-approval can vary from lender to lender, your professional circumstances, and your financial situation. The paperwork required can also be affected by the reasons you are buying the property, such as rental income and the type of loan you are using.
Consider shopping around mortgage lenders to learn what they need from you to help you get pre-approved for a loan. Once you submit the paperwork, it can take up to 10 business days to get pre-approved.
At Finance is us, we provide advice to help you get your finances on track so you can afford your dream home.
Disclaimer: All content on this site is information of a general nature and does not address the circumstances of any particular entity or individual, nor is the information a substitute for professional financial advice and services.