A mortgage preapproval, which is not the same as a mortgage prequalification, is an important first step in the homebuying process. It will help you understand how much you can afford, what it will cost you, and help you set a budget.
It can also give you an edge in a competitive real estate market as most sellers will require a preapproval before considering your offer.
First, it’s important to understand the difference between a mortgage preapproval and a prequalification, as they are not the same. Both terms are commonly used in the approval process, which may be confusing at times.
Similar to a preapproval, mortgage prequalification serves as the first step in the homebuying process. It is an initial assessment of your financial situation, based on the information you provide to a lender. The key difference between prequalification and preapproval is that the lender does not review the information provided during prequalification.
During the prequalification process, you will provide basic financial information such as your income, debts, assets, and credit score. The lender will then use this information to offer you a rough estimate of the amount you may be eligible to borrow.
Mortgage preapproval is a more in-depth process than prequalification. During preapproval, a lender will review your credit report, income, assets, and debts to determine how much they are willing to lend you to buy a home. Preapproval involves submitting documentation to your lender, including tax returns, bank statements, and employment verification.
Why Is a Mortgage Pre-Approval Important?
It Will Help You Find Out How Much You Can Afford
A preapproval will give you a clear idea of how much money you can borrow from a lender. This will help you set a budget and narrow down your search for a home to properties that are within your price range.
Can Give You an Edge in A Competitive Market
In a hot real estate market, homes can sell quickly. Having a preapproval can give you an edge over other buyers who may not have one. Without a preapproval, sellers and most real estate agents may not entertain your offer or assist in drafting one on your behalf.
Once you have found a home you want to buy, having a preapproval can expedite the closing. As you have already undergone the initial underwriting process, your lender will require less time to finalize your loan. This is a significant advantage for most sellers.
How Do I Get Pre-Approved for A Mortgage?
Gather Your Financial Documents
You’ll need to provide your lender with documents that verify your income, assets, and debts. This may include pay stubs, W-2s, tax returns, bank statements, and investment account statements.
Shop Around for Lenders
Not all lenders are created equal. Shop around and compare rates and terms from different lenders to find the best one for you.
Submit Your Application
Once you’ve chosen a lender, you’ll then submit your application. This may be done online or in person.
Wait For Your Pre-Approval
The lender will review your application and financial documents and determine whether to pre-approve you for a mortgage. If you’re approved, you’ll receive a preapproval letter that you can use when making an offer on a home.
Key Factors That Lenders Consider Before Pre-Approval
Your Credit Score and History
Lenders will review your credit score and history to determine your ability to make payments on time and manage debt. A higher credit score can increase your chances of being approved for a mortgage and may result in a better interest rate.
Employment History and Income
Lenders will want to verify your employment history and income to ensure that you have a stable source of income and can afford to make mortgage payments. Self-employed individuals typically have stricter underwriting standards.
Your debt-to-income ratio represents the amount of debt (monthly obligations) you have in comparison to your income. Lenders typically prefer a debt-to-income ratio of 43% or lower.
Lenders will want to review your assets, such as checking, savings, money market, or certificate of deposits, to determine if you have the financial resources to make a down payment and cover closing costs.
Loan-to-Value (LTV) Ratio
The loan-to-value (LTV) ratio is evaluated by lenders as part of their risk assessment process when approving a mortgage. Loans with higher LTV ratios are generally viewed as carrying higher risk, which could result in a higher interest rate if the mortgage is approved.
If you have a specific property in mind, lenders will want to review information about the property, such as the appraisal value, property condition and property taxes, to determine the loan amount and terms.
How Long Does Mortgage Pre-Approval Take?
The time it takes to receive preapproval depends on your lender and how quickly you provide them with your application package. Some lenders provide same-day preapprovals, while others may take a few days or longer.
How Long Is a Pre-Approval Good For?
A mortgage preapproval is typically valid for 60 to 90 days, though the duration can differ based on the lender and various other factors.
If your application profile remains unchanged, and you provide your lender with updated financial information, you can typically extend your preapproval. This is an important consideration, as it ensures that you maintain your eligibility for the loan.
When Should I Apply for a Pre-Approval?
The sooner the better. This approach can help you identify any potential hurdles in obtaining preapproval, such as high levels of debt or a subpar credit score. Additionally, obtaining preapproval enables you to establish a clear understanding of the price range you can afford and what it will cost you.
What Not to Do After Pre-Approval
Avoid Applying for New Credit
This can impact your FICO score and debt-to-income ratio, two key factors for lenders when reviewing your application.
Don’t Miss Any Payments
Payment history is another key factor for lenders to consider. Any missed payments on credit cards, auto loans, or any other installment loans that appear on your credit report can have an impact on your FICO score. For first-time homebuyers, their rental payment history is also important.
Avoid Large Purchases
Paying for a significant purchase in cash will decrease your available assets, which your lender has considered during your preapproval evaluation. On the other hand, making the payment through a credit card will increase your debt-to-income ratio and may also have an impact on your credit score.
Avoid Changing Jobs, Especially If It’s in A New Field
Lenders generally want to see a consistent 2-year employment history in the same field of work. And in most cases, they also want to see a 2-year history in how you are paid. For example, going from a salary position to a commission only position, even in the same line of work, can lead to a denial by the lender.
Avoid Moving the Assets You Have Listed on Your Application
Lenders typically verify all your available assets for at least 60 days before providing a preapproval. Moving your funds around will require the lender to re-verify your assets, and you will be required to provide a paper trail for all the transactions.
What Can Go Wrong After Pre-Approval
While obtaining preapproval for a mortgage is essential, it does not guarantee that your loan application will be approved, as there is still a chance of being denied.
If your application and credit profile have not changed, the lender will have to verify the following before providing final approval:
Lenders will require an appraisal of the property to ensure that the fair market value is equal to or higher than the purchase price. The appraisal will also inform the lender if the property meets minimum safety requirements and if it is in compliance with local city ordinances.
Change in Guidelines
Lending guidelines are subject to change, and lenders may modify their underwriting criteria even after granting you preapproval. This is why it is crucial to include a loan contingency with your offer.
Lenders require a clear title to be delivered at closing, which means that no outstanding mortgages, liens, judgments, claims, or other encumbrances exist against the property. This will be processed by a title company that will also issue a lender’s title insurance policy.
Should I Get Pre-Approved by More Than One Lender?
Certainly. By applying to various lenders, you can compare interest rates and fees and select a mortgage that best suits your financial situation, potentially resulting in significant savings throughout the life of the loan.
Does Getting Multiple Pre-Approvals Hurt Your Credit Score?
Each time you apply for a preapproval, a lender will need to check your credit with either a “hard inquiry” or a “soft inquiry”, depending on their process.
A hard inquiry can lower your score by a few points. However, according to FICO, your credit score shouldn’t be affected if you make all your inquiries on a home loan within a 30–45 day period.
A soft inquiry, also called soft credit check or soft credit pull, does not show up on your credit as an inquiry and does not affect your credit score.
Buying a home can be a stressful process. Not knowing your purchasing power, associated costs, and potential surprises while underwriting your loan application along the way can add to the stress. It’s best practice to apply for a preapproval as soon as you’ve decided to buy a home to alleviate some of that stress.
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