In 2021, banks and lenders issued 15 million home loans to Americans buying houses. If you’re considering a mortgage, it’s in your interest to get pre-approval before starting to shop for houses. Mortgage pre-approval occurs when a bank assesses your financial situation to determine how much you would be allowed to borrow, in addition to a conditional interest rate.
However, in order to get the best pre-approval offer possible, there are a few key things to know and keep track of. Learn more about pre-approval for a mortgage and how the process works.
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What Is a Mortgage Pre-approval?
In a mortgage pre-approval, a lender looks at your financial information to determine if you may be eligible for a mortgage. They might ask for copies of your paystubs, bank account statements, and tax returns to get an accurate picture of how much money you make. In addition, they might also perform a credit check that pulls information on your credit card debt, payment history, and types of accounts you currently have.
Using all this information, the lender creates a pre-approval letter explaining how much you can borrow and sometimes at what rate. It’s usually valid for around 90 days. If you do not officially apply for a mortgage by then, you’ll need to reevaluate your finances and any changes in interest rates, which could affect how much of a loan you can get.
Overall, a mortgage pre-approval is a powerful tool for helping you see how much you can actually afford. It also shows sellers you’re serious about bidding for and buying a house. Further, it may strengthen your offer by providing you with an angle to negotiate from.
Pre-approval vs. Pre-qualification-
While some lenders might use the terms “pre-approval” and “pre-qualification” interchangeably, they mean different things. Pre-qualification is a less-stringent version of a pre-approval. In pre-qualification, lenders ask you about your financial information but don’t check it for themselves by running a credit report. Therefore, it does not provide as accurate of information as a pre-approval.
Pre-qualification is better if you want a more realistic picture of how much you can afford but aren’t necessarily serious about buying a home. Pre-approval, on the other hand, is better if you want to see how much you can afford and are ready to begin home shopping right away.
Is Getting Pre-approval a Guarantee For Getting a Mortgage?
A pre-approval does not guarantee you can get a mortgage. Your ability to get a mortgage depends significantly on your financial information. Once you apply for your mortgage, your lender goes far more in-depth into your financial history than it did with pre-qualification.
If your lender finds an issue, like your income isn’t verifiable or your tax returns don’t match up, it can back out of giving you a loan. You also need to have your home appraised to make sure it’s worth what you’re paying; otherwise, your lender might refuse to offer you a loan.
Do You Need Pre-approval for a Mortgage?
Getting a pre-approval letter isn’t necessary to secure a mortgage. However, it can significantly improve your chances of securing the home you want. Firstly, it helps you establish a reasonable budget. Knowing the top range of your loan can help you limit your search to homes you can afford. If your budget comes in lower than you’d like or your lender doesn’t offer you a pre-approval, you can strive to improve your financial situation before looking at houses.
Second, it shows sellers you’re serious. A seller doesn’t want to accept an offer, then have the sale fall through a month later because the buyer couldn’t get a mortgage. It’s safer for them to choose an offer with a pre-approval letter attached because it helps them know financing isn’t an issue. Having your mortgage pre-approval ahead of time also lets your real estate agent submit your offers faster, which is vital in a seller’s market.
When to Get Pre-approval
Ideally, you want to start the mortgage pre-approval process right when you’re ready to begin house hunting. Mortgage pre-approvals are good for around 90 days, so if you apply for one too early, it might not be valid when you’re ready to submit an offer.
Getting pre-approved a second time means the lender has to make a hard credit inquiry again, and this time, your credit score might be a bit lower. That’s because every hard credit inquiry has a small effect on your credit score, lowering it by about 3-10 points. Remember that this reduction of your credit score could affect your interest rates and the max limit of your mortgage, especially if you’re on the edge of falling into a lower credit category.
When to Consider Skipping Pre-approval
There are a few occasions when you can skip pre-approval. For example, if you’ve recently been pre-approved and know that your finances and credit score haven’t changed much, it might not be worth it to take the credit hit by having another hard credit inquiry done.
You can likely rely on the old numbers and have everything finalized when it’s time to apply for the mortgage. Additionally, if you’re thinking of making a down payment so large that you might need a smaller loan, it might not make sense to bother with pre-approval.
What Are the Steps of Mortgage Pre-approval?
It can take some time to receive your mortgage pre-approval letter. While some banks promise results in 5 minutes, these processes are more akin to a pre-qualification letter. A true pre-approval can take up to 10 days to calculate.
Because of the lengthy approval period, it may be a good idea to begin the process right when you’re about to start looking for homes.
Once you’re ready to get started, follow these steps:
Get Your Identification and Financial Documentation Together
Your mortgage pre-approval requires you to verify your income, employment, assets, and debts. Gather the following documents for your lender:
- Tax returns from the past two years
- W-2 or 1099 forms from the past two years
- Pay stubs from the past 30 days
- Bank statements from the past two months
- Brokerage and retirement account statements from the past two months
- Mortgage and tax records of other owned properties
- Previous divorce or bankruptcy documents
Seek Quotes From at Least Three Mortgage Lenders
It’s considered best practice to get pre-approval quotes from three different lenders. Lenders have different formulas for computing a mortgage loan based on your credit score and credit report, so it’s helpful to shop around to find better terms. The good news is that whenever you request multiple credit checks within 45 days, they only count as one check. Therefore, you do not receive multiple hits on your credit score if you get your quotes within that timeframe.
Compare Your Options
When you get quotes, the first thing to consider is your interest rate. However, take special notice of the annual percentage rate (APR), the actual annual cost of your loan. APR is different from simple interest because it includes fees and other administrative costs.
Your loan amount and type are also crucial; ensure each lender has quoted you information for the same type of loan. Lenders will also include your estimated monthly payment, including principal, interest, and mortgage insurance, if needed. Look to see if this is a number you can comfortably afford.
Complete the Pre-approval Process for Your Favored Lenders
After you narrow it down to one or two lenders, go through the full pre-approval process to check the accuracy of the quotes. Since the lender already has your basic information, this process may take a few minutes. However, if your lender wants to see more detailed financial information, it could take a few additional days to process.
Why Lenders May Deny Your Pre-approval Application
It’s possible that a lender could deny your pre-approval application. There are a few reasons why this could occur. The primary reasons are that you don’t make enough money, you have too much debt, or your credit score is too low.
Many lenders use your debt-to-income (DTI) ratio to determine if you can take on a mortgage. DTI is a number, expressed as a percentage, that weighs your monthly income against your monthly debt, with 40% constituting a “good score.” Keep in mind that what may be considered a good score varies by lender.
Pre-approval usually requires a DTI ratio of 43% or lower. Therefore, your debt has to be less than 43% of your total income. As an example, let’s say you make $4,000 a month. You could not have more than $1,720 in total monthly debt to get a mortgage.
Your credit score is also crucial when applying for a mortgage. Some loans allow a credit score as low as 500, but a mere 4% of homebuyers who got a mortgage had a credit score under 620.
How To Increase Your Chances of Pre-approval
If you want to improve your chances of getting a mortgage pre-approval, you can try plenty of things. Consider the following practices in the months before you apply:
- Improve your credit score: Paying off credit card debt, making on-time payments, opening new lines of credit, and consolidating your loans can help you improve your score.
- Find a higher-paying job: Getting a raise may be easier said than done, but it’s a simple way to increase your chances of pre-approval.
- Increase your down payment: The more money you pay upfront, the less your lender has to loan you. If you show them you’re willing to pay more than 20% (and have the funds to do so), they might be more lenient with your pre-approval and interest rate.
- Secure a cosigner: Having another person (ideally with a higher credit score and more assets) cosign on your loan gives the bank more reassurance that you can pay them back.