In order to get preapproved for a mortgage, you need to provide your lender with extensive documentation proving your income, assets and debt obligations. If you qualify, you’d get a preapproval letter indicating how much you can borrow to purchase your new home. This article will explain mortgage preapproval step-by-step. We can also help you find a financial advisor who would guide you through the entire house hunting process.
What Is Mortgage Preapproval?
When a lender preapproves you for a mortgage, it tells you exactly how much it’s willing to loan you to pay for a home. That decision hangs on a thorough review and verification of your financial, credit and employment history. Your preapproval will come in the form of a letter. It will also contain an initial interest rate as well as terms of the loan.
Mortgage preapproval significantly boosts your chances in the housing market. For starters, most real estate agents expect you to be preapproved for a mortgage before you knock on their doors. Think of it as a seal of approval that tells agents you’re someone they can trust, and you’re serious about buying a home.
The entire process takes about two-to-four weeks. But some lenders claim they can approve you online within an hour. Regardless, mortgage preapproval requires certain documentation.
But even before you begin digging, you may need to take a few first steps.
Before Getting Preapproved
Your credit history can heavily influence whether you get preapproved for a mortgage at a reasonable interest rate. Lenders typically offer the best rates to people with high credit scores. As a general rule of thumb, a score of at least 740 should secure you a reasonable conventional loan.
Generally, you’d need a credit score of at least 620 to secure an FHA loan, a government-backed mortgage that usually carries a smaller interest rate than a conventional mortgage. Your lender may still preapprove you if your score dips lower. But expect a larger interest rate, down payment, and home insurance. You can access your credit report online for free to see if you’d be better off improving your finances before moving forward.
But if you feel ready to move forward, get ready to do some research.
What Do You Need to Get Mortgage Preapproval?
Your lender will run a thorough search of your financials. To avoid any future headaches and expedite the process, have the following documents at hand:
Proof of identity: Gather your driver’s license or government-issued ID, passport, Social Security card and other documents that verify who you are and where your permanent residence is.
Proof of employment history: Most mortgage lenders require the last 30 days of pay stubs that also indicate your year-to-date income.
Tax documentation: Gather your last three federal and state tax returns along with your last three W-2 forms. If you’re self-employed, you can collect your most recent 1099 forms.
Bank statements: Your mortgage lender will take a deep dive into your cash flow. So gather the last three months worth of financial statements for all your accounts. This may include checking, savings, money market, and certificate of deposit (CD) accounts.
Asset information: You should also collect statements for brokerage accounts or other taxable investment vehicles. Proving you have assets at hand would serve you well in the mortgage preapproval process.
Retirement account statements: Even if you don’t want to borrow from your 401(k) to cover a down payment, you should still make it clear to your lender that you have tax-advantaged assets like a 401(k) or an individual retirement account (IRA).
Records of debt obligations: Your lender wants to get a crystal clear picture of your debt-to-income ratio to determine what you can afford to pay back. So be ready to provide documentation of all your financial responsibilities. This can include rent, utilities, student loans, living expenses and more.
Real estate income: If you’re earning income from any property, you’d need to provide specific paperwork. Examples include a lease and documentation of rental income for the last three years. You’d also need to prove the current market value of the rental property.
Documentation of irregular income: Maybe you’re getting help from family members or friends to make your down payment. Reach out to these people and ask for letters indicating they made these gifts to you and they don’t expect to be paid back. Furthermore, you’ll need to provide documentation of any additional income such as bonuses or alimony payments. Overall, keep a record of all money coming in.
Shop Around for Different Mortgage Lenders
Do your homework. Hundreds of mortgage lenders around the country want your business. And despite tight regulations, not all are going to offer you the best mortgage rates and terms. So shop around and don’t worry about how the search will affect your credit score.
Generally speaking, any inquiry into your credit history by a firm scratches a little off your credit score. But according to a recent report by the Consumer Financial Protection Bureau (CFPB), every credit score check from a mortgage lender within a 45-day window counts as one search. So take advantage of those 45 days.
What to Do After You Get Preapproved for a Mortgage?
After a lender preapproves you for a mortgage, the road toward your dream home continues. Preapproval usually comes in the form of a letter proving that a lender has verified your information and is willing to give you a specific loan.
However, it’s typically valid for 60 to 90 days. So you can take that time to check out different real estate agents and home sellers.
But remember, you earned preapproval because you demonstrated your trustworthiness as a responsible borrower. If you fail to maintain that reputation, you can face some serious consequences.
Your lender may reduce the amount you can borrow, raise your interest rate or revoke the preapproval if you fail to maintain a good financial standing. That means don’t make any huge purchases without running it by your lender first. Lenders keep their eyes on your debt-to-income ratio. So avoid taking on new large debt.
In addition, avoid opening any new lines of credit. Each credit inquiry will knock down your credit score and change your credit capacity. Your lender may also get suspicious of your financial standing if you suddenly have the potential to rack up even more debt.
Instead, focus on paying off your current debt and keep paying bills on time to boost your credit score. A different lender may take notice of your improved credit score and offer you a better interest rate.
Once you’ve found a home you’re ready and able to commit to, your lender will move your mortgage preapproval onto the final application phase. The loan finalizes when an appraisal of the home is done, and your mortgage is tied to a particular property.
What If You Don’t Get Preapproved?
Don’t panic if a lender rejects your mortgage application on the first run. Look into a different lender or ask for your mortgage application to be reviewed by someone else in the firm that turned you down the first time.
If the lender gives you a second chance, prepare to defend your case. Maybe a rare blow to your finances such as an unforeseen medical expense crippled your chances at securing a mortgage. Draft a well-written letter explaining this as a one-time event that shouldn’t overshadow your otherwise solid financial foothold.
But if you still don’t manage to get preapproved for a mortgage, you may need to make some changes to your financial situation. Take it as an opportunity to improve and better yourself. Maybe you need to cut back on unnecessary expenses or develop a better budget. Maybe you need to launch a better savings strategy or tackle other debt. In the end, you may walk away with a financial wellness and a mortgage with a much more manageable interest rate.
Know the Real Costs of a Mortgage
Financing a home can be a 30-year commitment, so make sure you’re ready to handle it. Furthermore, lenders require down payments before your mortgage kicks in. Down payments typically range from 3.5% to 20% of the home’s purchase value. For example, consider a home worth $200,000. If you’re making a 20% down payment, you’ll need to pay $40,000 up-front.
When it comes to a mortgage, a monthly payment doesn’t typically break down into just what you pay in interest and what you pay off the principal, the amount you initially borrowed. You may also need to factor in property taxes, insurance, and homeowners association fees.
Be sure to ask your lender all about fees and payments of any kind. Also, keep in mind that you’d need to have a strong emergency budget to fund unexpected home maintenance expenses.
You’ll also have to pay closing costs. These payments may include application and administrative fees as well as title fees and lender origination fees. You may owe attorney’s fees in states requiring lawyers present at real estate transaction closings.
Most real estate agents expect you to be preapproved for a mortgage before they even open the door. The process may seem extensive, but preapproval tells sellers you’re a serious buyer and you mean business. So gather all your paperwork, shop around for lenders and get ready to step into your dream home.
Tips for Getting Mortgage Preapproval
- Mortgage preapproval requires extensive documentation and research. So always have a mortgage preapproval checklist by your side.
- Purchasing a home may be the biggest and most important investment you’ll ever make. But you can run into some pitfalls before you call your dream home truly yours. That’s why the guidance of a qualified financial advisor can be crucial for you and your family during this process. We can help you find one with our financial advisor matching tool. You just answer some questions about your finances and goals, and it’ll link you with up to three financial advisors in your area. You can also access their profiles, so you can review their experience and credentials before working with one.
Photo Credit: ©iStock.com/fizkes, ©iStock.com/Tijana87, ©iStock.com/ sturti