One of the biggest financial steps you’ll take in your life is getting a mortgage. Before you start looking for a home, it helps to know how much a lender will loan you. That’s where mortgage preapproval comes in.
So, how to get preapproved for a mortgage? As you get ready to achieve your dream of homeownership, here’s what you need to know.
What is a mortgage preapproval?
When you are preapproved for a mortgage, you aren’t guaranteed a home loan. However, the preapproval does offer a conditional commitment. The lender is saying that, given your financial information, you can expect a set amount toward a home purchase.
Your mortgage preapproval lets you know how much you can borrow, estimated monthly payment, and interest rate. Additionally, you should receive an approval letter to show sellers and real estate agents proving you can afford the house.
Preapproval vs. prequalification
Don’t confuse a mortgage preapproval with a mortgage prequalification. A prequalification can give you an idea of what to expect, but it’s not as rigorous.
With a mortgage prequalification, the lender or mortgage broker offers you a ballpark estimate of what you might be able to borrow based on information you provide. You tell them your approximate credit score, your income information, and how much you can offer as a down payment.
This is a good way to compare mortgage interest rates and terms from different lenders. However, many sellers and real estate agents won’t accept a prequalification as proof of what you can afford.
When you are preapproved for a home loan, you have to provide documentation of your situation, not just estimates. You may need to pay a fee for a credit check, and you’ll need income documentation and bank statements that show assets and liabilities. With more information about your situation, lenders are more comfortable committing to give you a home loan.
Starting the mortgage process
Your mortgage preapproval is often considered the first step in the mortgage process. Use prequalification from multiple lenders to get an idea of possibilities and terms. After you settle on one lender or broker, you can fill out the application for preapproval.
Documents needed for mortgage preapproval
Because you need documentation to get preapproved for a mortgage, it’s important to come prepared. Ask your lender or mortgage broker about what you need to provide. Create a list and check off each document as you collect it.
In general, you can expect to hand over the following documents:
- Identifying documents (driver’s license, passport, or state ID).
- Pay stubs for the last 60 days.
- Two years of federal tax returns (including W-2s).
- Bank account statements (savings and checking) from the last 60 days.
- Investment account statements (including retirement accounts) from the last quarter.
If you are self-employed, you may need to agree to an income audit or provide a list of regular clients who can back up your claims of consistent income.
On top of that, if you are in a situation that impacts your finances, such as a divorce decree or bankruptcy discharge papers, you may need to provide further documentation. Rental income requires a copy of the lease agreement.
Speak with your loan officer or broker about your financial situation and any circumstances that might impact your ability to pay your mortgage. They will let you know what additional documentation you need to complete your preapproval application.
Down payment documentation
Lenders follow a paper trail for your down payment as well. You need to show the origin of the money for the down payment.
If you are moving it from your savings account for the purpose of a down payment, provide the bank statements that prove your habit of saving up over the years.
You usually can’t use credit cards or other loans for your down payment. If you’re getting money from loved ones, they might need to provide gift letters. These letters explicitly state you are receiving a monetary gift free and clear and you aren’t expected to repay it.
If anything looks suspect, a lender may not count it toward your positive financial situation or consider it for your down payment. You stand a better chance for a preapproved home loan when you have a paper trail for your finances.
Your credit score
If you want to get preapproved for a mortgage, you need decent credit. Most conventional lenders won’t approve you unless you have a credit score of at least 620. If you want the best outcome for an FHA loan, you need at least a 580.
It’s possible to get a mortgage with a lower credit score, but it’s difficult to get approval. Plus, you’ll pay for it later with a much higher mortgage rate.
Before you seek a mortgage preapproval, check your credit. A quick look with the help of a free website can be enough for prequalification, but when you’re ready to get serious about preapproval, you need to know your FICO score. See how to see your score for free here.
While the score used by a mortgage lender will be slightly different to what you see, it can clue you in if there are issues.
You can also see if you legitimately need to make some improvements to your credit. A few months of on-time payments plus an effort to pay down some of your debt can help you give your credit score a boost and increase the chances of a preapproval with a competitive interest rate.
Your preapproval letter
Once you get preapproved for a mortgage, you will receive a preapproval letter. This letter acts as the proof you need to show real estate agents and sellers you’re serious about a property and that you can afford it.
Your preapproval letter usually includes the type of loan, the loan amount, and the qualified interest rate.
Make sure you “lock in” your interest rate during the preapproval process. Talk to the lender about how you can be protected against rate increases and ask if you are guaranteed the lower rate if mortgage rates fall.
The home buying process can take several weeks, and mortgage rates fluctuate regularly. You want to avoid an unpleasant surprise if mortgage rates shoot higher the week after you start home shopping. Get the interest rate policy in writing.
Depending on the lender, your preapproved home loan terms (and the letter) will likely be good for between 60 and 90 days. If you don’t find a home before it expires, you’ll need to have the lender update their preapproval.
Preapproval isn’t a guarantee
You will finish the mortgage process after the seller accepts your offer on a home. However, just because you get preapproved for a mortgage doesn’t mean you’re home free.
Until the home’s closing, things can go awry. If you lose your job or your credit situation changes significantly, your mortgage may be at risk.
Another concern is the home’s appraisal. Even if you are preapproved for a set amount, the lender might not go through with the loan if the home’s purchase price is higher than the appraised value.
After you receive your mortgage preapproval, stay on top of your finances until you close on the home. Some of the things to avoid after your preapproval include:
- Applying for new lines of credit.
- Making major purchases, especially with your credit card.
- Cosigning a loan for someone else.
- Paying your bills late.
As you wait to complete the mortgage process, make sure you answer your lender’s requests for additional information and documentation promptly. You don’t want the process to fall behind because you were to slow to respond.
The key is continued contact with your lender so that everyone is in the loop. Whenever something major comes up, such as a job change or a bonus, consult your lender. That way, you avoid surprises later.
Just because you’re preapproved doesn’t mean it’s a smart buy
Your mortgage preapproval relies on your income, credit, debt-to-income ratio, and down payment. A lender or broker will review your documentation and figure out how much they are willing to lend you, based on your projected monthly payments.
However, just because a lender says you can afford to pay $1,500 a month on a mortgage doesn’t mean you should borrow the full approved amount.
Use the preapproval letter to show you can afford a home, but only buy something in a price range you can comfortable afford. It might mean buying a home that’s a little smaller, but you’ll avoid being house poor.
Even though it can be a hassle to learn how to get preapproved for a mortgage, it’s worth it. Spending a little extra time now to gather documentation and work on your credit can save you time and money later on in the mortgage process.