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Mortgage Preapproval: Everything You Need to Know

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If you’re thinking about owning a home, you’ll likely need a mortgage preapproval. A home loan preapproval gives you a snapshot of what you can afford based on the program you apply for.

A preapproval letter shows sellers you’re solid financially, and if there’s a lot of competition for homes in your area sellers won’t consider your offer without one. Knowing the ins and outs of a mortgage preapproval will give you the edge you need to compete against other less prepared homebuyers.

Things to know first

Knowing how to get preapproved for a mortgage gives you an edge before you start house hunting

Many sellers won’t consider an offer without a mortgage preapproval letter

There’s a big difference between a prequalification and a preapproval

Make sure you pick the right loan type for your mortgage preapproval

Have your financial paperwork ready before you apply for a preapproval

Learn what steps to take if you’re denied for a preapproval

What is a mortgage preapproval?

A mortgage preapproval is a preliminary green light from a lender for a home purchase based on a review of your credit, debt, income and down payment funds. Lenders typically issue a preapproval letter detailing the maximum amount you can borrow based on the loan program you apply for.

Prequalification vs. preapproval

Lenders and real estate agents often use the terms prequalification and preapproval interchangeably, but there are important differences. Getting prequalified for a mortgage is based on casual conversation about your credit scores, earnings, monthly debt payments and the source of your down payment (if needed). The lender relies on information you provide without vetting it with financial documents and, in some cases, without pulling a credit report.

With a mortgage preapproval, the lender usually requires you to complete a loan application and provide basic financial documents like pay stubs, W-2s and bank statements. The lender will also pull a credit report from the three major credit bureaus — Equifax, Experian and TransUnion — to see how you’ve managed credit over time.

How to get preapproved for a mortgage

Although you can get a mortgage preapproval online, you’ll still need to gather some financial documents to apply for a home loan. Generally, you’ll need to provide:

  • Current pay stubs
  • W-2s from the past two years
  • Bank statements from the last 60 days
  • Employer contact information from the last two years
  • Addresses you’ve lived at the past two years

You may need additional paperwork to document any unique income, credit or application issues such as:

  • A divorce decree to show debts paid by an ex-spouse
  • Proof of child support you receive or pay
  • Bankruptcy documents
  • Past-due federal debt or tax payment plans
  • Proof someone else pays cosigned debt (like student or auto loans)

Self-employed borrowers: Different rules apply

If you have 25% or more ownership in a business you earn income from, you’re considered a self-employed borrower, and will have to provide more paperwork to get a mortgage preapproval. Because your income isn’t guaranteed, lenders take extra care to make sure the income is stable enough to repay the loan.

Lenders that offer self-employed mortgages typically average the personal earnings reported on tax returns for the last two years. They often analyze business tax returns to make sure the company is stable, and may require profit and loss statements and letters from a CPA to explain how your income is received.

When should you get a mortgage preapproval?

You should get a mortgage preapproval if you’re serious about looking for and making an offer on a home within the next two months. Preapproval letters are good for 30 to 60 days, according to the Consumer Financial Protection Bureau (CFPB).

If it takes you longer than a month or two to find a home, the lender may need to update your preapproval with more recent pay stubs and bank statements. If your house hunt takes more than 90 days, the lender may also need to pull a new credit report, which may impact your credit score.

How the mortgage preapproval process works

There are five basic steps in the mortgage preapproval process.

  1. Compare lenders. You can meet a lender in person, by phone or online, but it’s best to compare rates from three to five different lenders before applying for a mortgage. Lower rates give you more borrowing power, so keep the loan estimates you gather to negotiate the best interest rates.
  2. Have your financial documents handy. Your mortgage preapproval is as good as the information you provide. Use the list above as a reference point for the paperwork you’ll need to get preapproved for a home loan.
  3. Apply for a mortgage loan.Double-check your entries to make sure they’re correct before you submit your application. You’ll have a limited negative impact on your credit score if you apply with more than one mortgage company within a 45-day period.
  4. Find out what your credit scores are. Your lender will check your credit from the three major bureaus and pick the middle score for your preapproval. Although some programs allow for scores as low as 500, your rate and preapproval process will fare better with a score above 740.
  5. Get your mortgage preapproval letter. If your credit, income and assets meet the minimum requirements for the loan program you applied for, the loan officer will issue a preapproval letter. Keep copies for your real estate agent when you’re ready to make purchase offers.

How long does a mortgage preapproval take?

Some lenders offer same-day mortgage preapprovals that include electronic verification of your employment, credit and assets. Others may take several days, depending on how complicated your financial situation is. Ask lenders upfront what their timelines are. Expect a longer wait if you have credit bumps or are self-employed.

What factors lenders consider when granting your mortgage preapproval

Lenders scrutinize all of your financial decision-making, from how you’ve managed credit to how stable your income is. Here’s a brief overview of the most important mortgage preapproval factors:

  • Your credit score. Your credit score will make or break a mortgage preapproval. Some loan programs permit scores as low as 500, but the road to preapproval will be very bumpy, and you’ll pay a higher rate. The gold standard is 740 for the lowest rate — taking these simple steps can help give you a boost before you apply:
    • Pay everything on time. Recent late payments will knock your score down faster than any other credit action.
    • Keep your credit balances low. Although it’s best to pay balances off to zero, try to keep your credit charges at or below 30% of the total amount you can borrow. For example, if you have $10,000 worth of credit, don’t charge more than $3,000 in any given time period.
  • Your monthly debt compared to income ratio. Your debt-to-income (DTI) ratio is as important as your credit score. Lenders divide your total debt by your pretax income and prefer that the result is no more than 43%, although some government programs may allow a DTI ratio up to 50% with high credit scores or extra mortgage reserves. The bottom line: You won’t be approved if your DTI ratio is too high, even if you have a perfect credit score.
  • Your down payment and closing cost funds. Most loan programs require a down payment of at least 3%. You’ll also need to budget 2% to 6% of your loan amount to pay closing costs. The lender will verify where the funds come from, which may include:
    • Money you’ve had in your checking or savings account the last 60 days
    • Gift funds received from a relative, nonprofit or employer
    • Funds received from the sale of an asset like a car or a 401(k) loan
  • Your income and employment stability. Lenders prefer a two-year-employment history of receiving full-time salary or hourly earnings. Commission, bonus, overtime or self-employment income has to be averaged over two years in most cases.
  • Your rainy day reserve funds. Known as mortgage reserves in the lending world, lenders may approve a low credit score or high-DTI-ratio applicant if you have several months’ worth of mortgage payments in the bank.

Different types of mortgage preapprovals

There are four standard loan programs offered by most lenders: conventional, FHA, VA and USDA. Here’s a brief overview of mortgage preapproval requirements for each one:

Conventional mortgage preapproval

Conventional loans are the most popular option, although they have more stringent requirements set by Fannie Mae and Freddie Mac than government-backed loans offered by the FHA, VA and USDA.

A conventional mortgage preapproval is a good option if:

  • You have a 20% down payment. Unlike government-backed loans, you won’t pay any private mortgage insurance (PMI) or guarantee fees if you can come up with at least a 20% down payment. Mortgage insurance repays lenders for losses if you default on your loan and they have to foreclose.
  • You’re buying a second home or investment property. Conventional loans allow you to buy vacation or rental homes, while government loans are restricted to primary residence purchases only.
  • You need higher loan limits than FHA loans allow. Homebuyers can borrow up to $647,200 for a single-family home in most parts of the country – much more than the $420,680 cap for most comparable FHA loans.

FHA mortgage preapproval

The Federal Housing Administration (FHA) insures FHA loans for borrowers with lower credit scores and higher DTI ratios. The extra credit flexibility comes with hefty FHA mortgage insurance expenses. The upfront lump-sum mortgage insurance premium fee of 1.75% is added to the loan amount, along with an annual mortgage insurance premium fee of 0.45% to 1.05%, which is divided by 12 and added to your monthly payment.

An FHA mortgage preapproval is a good option if:

  • You have credit scores below 620. FHA guidelines allow for scores down to 500 with a 10% down payment, and 580 with the minimum 3.5% down payment.
  • You have a high DTI ratio. FHA lenders may approve you with a DTI ratio of 50% or higher if you have good credit or extra mortgage reserves.
  • You want to buy a multifamily home with a 3.5% down payment. One unique feature of FHA loans is the ability to buy a two- to four-unit home with a 3.5% down payment, if you’re willing to live in one of the units and rent the other(s) for at least a year. An added bonus: You can qualify with the rental income on the unit(s) you don’t live in.
  • You’re borrowing within the FHA loan limits for your area. You’ll be capped at $420,680 in most parts of the country, which will limit your borrowing power compared to conventional loans.

VA mortgage preapproval

The U.S. Department of Veterans Affairs (VA) guarantees loans made to retired and active-duty military borrowers, reservists and eligible surviving spouses. VA borrowers with enough VA entitlement may buy a home with lenient credit requirements and no down payment. No mortgage insurance is required. Instead, a VA funding fee of 1.4% to 3.6% is charged based on your down payment and whether you’ve used your home loan benefits before.

A VA mortgage approval makes sense if:

  • You have enough entitlement to buy a home with no down payment. VA borrowers must provide a certificate of eligibility (COE) that shows enough entitlement for a VA loan. It’s possible to buy more than one home with no down payment, which comes in handy for military families relocating due to military service.
  • You want a no-down-payment loan for an expensive home. Loan limits don’t apply to VA loans, which gives eligible military borrowers an edge over civilian borrowers to buy higher-priced homes without a down payment requirement.

USDA mortgage preapproval

The U.S. Department of Agriculture (USDA) guarantees loans for low- to moderate-income homebuyers in rural areas defined by the USDA. Borrowers can obtain no-down-payment financing, but pay two types of guarantee fees that work much like FHA mortgage insurance.

A USDA mortgage approval makes sense if:

  • Your household income is within the USDA limits. The USDA loan is meant to help borrowers with limited earnings potential, and lenders scrutinize the income of the entire household, even if they aren’t on the loan. You can find the median income limits for your area on the USDA website.
  • You’re buying a home in a USDA-designated rural area. Before you apply for a USDA loan, check the USDA property eligibility map to make sure the area you’re looking in is approved for USDA financing.

Below is a snapshot of the minimum mortgage preapproval requirements for all four of these programs.

Loan programMinimum credit scoreMinimum down paymentMaximum DTI ratio
Conventional6203%45%*
FHA500 (with 10% down payment)3.5% (with 580 credit score)43%*
VANo guideline minimum (620 lender standard)0%41%*
USDANo guideline minimum (640 lender standard)0%41%*

*Some exceptions may be made for borrowers with higher DTI ratios who also have ample cash reserves, residual income or other mitigating circumstances.

Mortgage preapproval vs. final loan approval

Once you get your mortgage preapproval, your lender takes steps to get you to the final loan approval process, which typically includes:

  • Getting an appraisal on your home. A home appraisal is usually required to verify your home’s value at least matches the sales price. A licensed home appraiser checks recent nearby sales of homes in your area and issues an “opinion of value” about its worth.
  • Getting title work to transfer ownership. A title company checks public records for prior owners, tax liens, judgments and any other “clouds” that could affect your ownership of the home. You’ll typically pay for title insurance to protect you against any claims the title company didn’t catch.
  • Getting a homeowners insurance policy set up. You can shop for homeowners insurance just like you can for mortgage companies. If you’re taking out a mortgage, the lender will need to be listed on your policy.
  • Meeting any conditions of the preapproval. The lender may ask for extra pay stubs, bank statements and letters of explanation before your closing. Once the appraisal, title work, homeowners insurance and all conditions are met, you’ll receive your final approval, and will be ready to close your loan.

What do I do if I’m denied for a mortgage preapproval?

The first thing to do is find out why your loan application was turned down. The most common reasons for home loan denial are high DTI ratios or low credit scores. Here are some tips for turning a mortgage denial into a mortgage preapproval.

If your DTI ratio is too high you can:

  • Pay off high-balance installment loans (like auto or personal loans)
  • Remove yourself from a cosigned installment loan
  • Ask someone to cosign on the loan with you
  • Lower your loan amount or sales price target
  • Make a bigger down payment
  • Choose a home without any homeowners association (HOA) fees

If your credit scores are low you can:

  • Pay off credit card balances
  • Add a cosigner (if you originally applied on your own)
  • Talk to a credit repair company
  • Dispute any late payments or errors on your credit report

Alternative mortgage preapproval options

If none of the tips above work to get you a standard loan, your loan officer may suggest an alternative or “non-QM” home loan product. Short for non-qualified mortgages, these mortgage programs offer temporary lending solutions. One caveat: You’ll need a bigger down payment and should expect to pay a higher rate for these types of loans.

Some of the most common non-QM loan types include:

Stated income loans. Instead of tax returns, lenders allow you to “state” your income and support it with 12 to 24 months’ worth of personal or business bank statements.

No-doc loans. These loans catered to investment property buyers rely exclusively on the estimated rental income to qualify.

Asset depletion loans. High net worth borrowers may be able to convert the cash value of an asset into income.

Recent major credit issue loans. Borrowers with large down payments and solid income may be able to take on a non-QM loan one day after completing a bankruptcy or foreclosure. Standard loan programs require a two- to seven-year waiting period.

FAQs about mortgage preapproval

Can I get a mortgage preapproval without a credit check?

No. However, you can get a mortgage preapproval without a credit score if you can show you’ve paid other obligations such as rent, car insurance, utilities and other accounts on time.

How long does a preapproval take?

It may take several minutes to several weeks to get a preapproval, depending on your financial situation. Ask your loan officer what their standard preapproval turnaround times are when you’re shopping for a lender.

How much does a preapproval cost?

In most cases, getting a preapproval should be free. Some lenders may charge an upfront application or credit report fee. Make sure you ask about upfront fees when comparing lender quotes. 

Should I get preapproved for the maximum I qualify for?

Yes, if you’re in a highly competitive market. Use a home affordability calculator to get an idea of how the payments will look based on different loan programs and down payments.

Can I get preapproved online?

Yes. Many lenders offer fully digital online mortgage approvals, and may even be able to access your employment, income and asset information with the click of a button.

Should I get preapproved by multiple lenders?

The CFPB recommends applying with several lenders and comparing options. However, once you find a home, you’ll need to make a final decision and stick with that lender until closing.

Will getting preapproved with multiple lenders hurt my credit score?

The impact to your credit score is limited, as long as the applications are made within a 45-day window. One other tip: Don’t apply for any new credit while you’re house hunting. Lenders will pull your credit again before your loan closes, and new debt could turn a mortgage preapproval into a denial.

 
 

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