Getting Pre-Approved for a Mortgage
One of the first steps in the homebuying process these days isn’t finding your next place to live, but finding a mortgage.
According to Marc Demetriou, a New Jersey-based mortgage consultant, the term “preapproval” is so common, you’d be hard-pressed to find many real estate agents who will show you properties if you don’t have one. So what does “preapproval” mean? Let’s break down the ins and outs of getting preapproved for a home loan.
What is a mortgage preapproval?
Before taking you house hunting, one of the first things many realtors will ask is if you’ve been preapproved for a mortgage loan. The homebuying process is a complicated endeavor that’s made even trickier if you’re up against a competitive housing market. Today’s landscape is one of high demand and low supply in many parts of the country. Mortgage interest rates are also on the rise, ranging from 3.3% to 4.7%.
In other words, it’s a seller’s market. South Carolina-based real estate agent Bill Olson told LendingTree that many sellers are taking their pick from multiple offers — those who don’t have a preapproval letter from their lender will likely fall to the bottom of the pile.
“You’re not only wasting valuable time by looking at homes without a preapproval letter, it’s also something that most sellers require because it’s essentially legitimizing your offer,” he told LendingTree. “Otherwise, your offer is just a piece of paper with some numbers on it.”
What is a preapproval letter? Getting preapproved means that a lender has provided you with a letter stating the estimated loan amount and mortgage rate you qualify for based on a review of your overall financial health. It’s slightly different from getting pre-qualified (more on this shortly), but both show sellers that your offer carries weight because you’ve got a lender behind you who’s ready to initiate financing.
“Going for a mortgage without having gotten a preapproval is like going to a surgeon without having had an X-ray,” said Demetriou. “It’s better to go in with an understanding of what you qualify for and what kind of rate and monthly payment you can expect.”
Not having a preapproval is akin to flying blind. You’re more inclined to look at houses that are out of your price range. On top of that, sellers are less likely to take you seriously if you make a bid without the backing of a lender.
How to get a preapproved for a home loan
A preapproval requires a deep dive into your financial health, but don’t fret — it’s actually a straightforward process that shouldn’t require too much of your time. According to Olson, most lenders require the following documents:
- Your ID
- Two full months’ worth of bank statements
- Verification of employment, usually in the form of one full month of pay stubs or two years’ worth of W2s (1099s if you’re self-employed)
Here are some other pieces of your financial well-being lenders may examine:
Credit history. The lender will look at your credit report, zeroing in on a few key details. Your credit score itself, which is determined by the information on your credit report, is a direct reflection of your creditworthiness. A low score or sketchy credit history is a red flag that suggests you’re a risky borrower.
A credit score of 620 is generally considered the minimum when applying for a conventional home loan, though that number may be lower for other types of loans. With a loan from the Federal Housing Administration or Department of Veterans Affairs, for instance, a score of 500 may be enough. The only downside is that if you’re applying for a conventional loan with a fair credit score, you’ll likely be on the hook for a higher interest rate.
Debt-to-income ratio. The preapproval process also takes into account your debt-to-income ratio (DTI), which highlights how much of your income is going toward debt payments. If it’s on the high side, you may not qualify for the loan amount you want or get the most competitive terms and rates. (You can figure out your debt-to-income ratio with this simple calculator.)
When applying for a mortgage, lenders generally look at two different types of DTI: front-end ratio and back-end ratio.
Front-end ratio is focused specifically on your housing debt; back-end refers to all your debt, including your housing payment. Lenders prefer lower DTIs — ideally no more than 43% for the back-end ratio, 31% for the front-end; this demonstrates that you have the capacity to absorb a new mortgage loan. However, these aren’t hard-and-fast numbers — some loans, like FHA loans, for instance, may allow a front-end DTI of up to 40% and 50% for the back-end, depending on the situation.
Lenders are simply looking for reassurance that you have the financial ability to repay the loan. And while it may sound complex, Olson says most lenders can process a preapproval within 24 hours.
It’s worth noting that getting preapproved is different from the mortgage application itself — that requires a much more thorough analysis of your financial health (something we’ll unpack in greater detail shortly). Put it this way: the preapproval is the first step on the way to homeownership.
Do I need more than one preapproval? Bear in mind that because getting preapproved requires a hard credit inquiry, it’ll result in a minor ding to your credit score, although Olson says it’s usually nominal because most homebuyers only need one preapproval.
“One is enough to start looking and to put an offer in,” he said. “The great thing is that if you want to shop around with other lenders, most will give you quotes based on the preapproval you already have, which means they won’t pull your credit again.”
Of course, if you end up moving forward with another lender, it will require another hard inquiry; this won’t likely occur if you go with your original lender.
Preapproval vs. pre-qualification
As your house-hunting journey becomes more focused, you’ll likely hear about pre-qualification. Like preapproval, it’s another way to show sellers that you’re ready to make a viable offer — however, there are some differences to understand.
“A pre-qualification doesn’t take a hit on your credit; it provides more of a rough guestimate price range while house hunting so that you don’t fall in love with caviar while on a hot dog budget,” said Olson.
In other words, pre-qualification is the first step in the homebuying process that’ll give you a rough estimate of your buying power, based on basic financial information you provide.
Preapproval is the first step in the loan process that takes a deeper dive into your finances to give you a more precise loan approval amount.
The Consumer Financial Protection Bureau doesn’t make too big of a distinction between the two, but pre-qualification, according to Demetriou, is becoming less common as preapprovals position themselves as the norm.
Benefits of shopping around for mortgage offers
Again, being preapproved by one lender doesn’t mean you’re beholden to them. In fact, it’s in your best interest to compare quotes.
“I recommend looking at a minimum of three lenders because the first offer isn’t always the best one,” said Olson. “If you do find a better rate, you can always bring it back to the first lender to see if they’ll meet or beat it.
“If you put them against each other to fight for your business, you can’t lose.”
According to LendingTree’s Mortgage Rate Competition Index, the biggest lifetime savings tend to go to borrowers who shop around. You can even get multiple quotes in a matter of minutes before you apply for an actual preapproval, thanks to this handy online form that seamlessly matches you to multiple mortgage lenders.
Alternatively, you can compare home loans by independently requesting quotes from different lenders on your own — just be forewarned that going this route is a time-consuming affair, and navigating the nuances of the mortgage industry may prove tricky, especially for first-time buyers. A mortgage broker can do the legwork on your behalf.
How to apply for a mortgage. It’s time to apply for the mortgage itself once a seller has accepted your offer on a property. “This is taking the information that was provided in the preapproval process and going through it with a fine-toothed comb, which may prompt the lender to request more documentation,” said Olson.
A prior bankruptcy or foreclosure, for example, may not show up on your credit report, but these things will surface when an underwriter is going through your financial history. Similarly, if you’re using any cash gifts to cover your closing costs or down payment, this also needs to be documented during this time. The main takeaway here is to remember that the preapproval isn’t an ironclad loan offer, but rather the first step in locking down a mortgage.
To give your mortgage application the best chance of being approved, Olson recommends resisting the urge to take out any new lines of credit or making any large purchases on existing credit while you’re in the thick of it, as this can “severely hinder your chances of closing on your home.”
If at all possible, try to hold off on any big job changes, like moving to a new employer or transitioning to self-employment, until after you’re approved since your ability to prove two years’ worth of steady income is the norm. On top of that, try to avoid receiving any large deposits during this time. If you do, be ready to prove to the lender where it came from and what it’s for. If you can’t, it could appear to be a new debt, which may derail your approval.
You can learn more about the different types of home loans and other steps for preparing for the mortgage application process here.
Important things to remember
It’s wise to get preapproved before you start making appointments with real estate agents. At the end of the day, having this letter in hand is what’s going to empower you to make the strongest offer possible when you do come across a home you want.
Get ahead of the process with this by getting mortgage loan offers, which will snag quotes from multiple mortgage lenders in a matter of minutes. When the time comes to complete a formal preapproval, gather the necessary financial documents and move forward with a lender you trust. One preapproval is likely all you need to shop around for the best rates and terms.
The most important thing to remember is that a preapproval puts you in the best position to stand out in today’s competitive housing market.