If you are in the market for a new home and require a mortgage, it’s essential that you get a pre-approval first. A mortgage pre-approval document proves that a lender has agreed to loan you a certain amount of money to buy your home.
Pre-approval can help streamline the home buying process and make your offers more competitive. Getting pre-approved also allows you to know your budget and house hunt accordingly.
However, to make sure your pre-approved mortgage goes through, you must ensure that your home meets specific criteria and that your financial situation does not change drastically during the home shopping period. Read on to find out how to get pre-approved for a mortgage.
Why Should You Get a Pre-Approval?
A mortgage pre-approval is not compulsory. However, getting pre-approved makes the home-buying process more efficient and provides an opportunity for you to compare loan options and solidify your budget.
It is important to be clear on your budget and the monthly repayments you can comfortably afford. This saves you time as you can eliminate homes that are out of your budget. It also prevents you from committing to a home that will stress your finances for years to come.
On top of this, pre-approval shows sellers and real estate agents that you are a serious buyer and can afford a home. Sellers want to know that a buyer can follow through with the financing. So being pre-approved gives you a much higher chance of having your offer accepted and securing your dream home.
Does Mortgage Pre-Approval Hurt Your Credit Score?
During the pre-approval process, a lender assesses your creditworthiness Then they determine the amount of money you can borrow and estimate your monthly payment. This will show on your credit report.
Like any credit check, this can lower your credit score. However, if you are seeking pre-approval from multiple lenders in a short time frame, they will only count as one hit on your credit report.
Key Factors for a Pre-Approved Mortgage
Pre-approval follows a review of a buyer’s financial profile. A favorable financial profile quickens loan and mortgage pre-approval and will qualify you for better rates. Lenders base a pre-approval on the following key factors:
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- Assets and liabilities
- Credit score
- Credit history
- Debt-to-income ratio
- Employment history
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Pre-Qualification Vs. Pre-Approval
Most people use these two terms interchangeably. However, they refer to different processes.
Pre-qualification is an estimation of your loan amount. It only involves a soft credit inquiry. No documentation is necessary for this process. Therefore, the lender only relies on your presentation of your financial situation.
Unlike a pre-approval, getting pre-qualified does not involve any commitment on the part of the lender. The mortgage rate they offer you could go up when you return to take out a mortgage. Pre-qualification documents cannot stand in for pre-approval when making your offer on a home.
Mortgage Pre-Qualification Checklist
For a pre-qualification, the lender requires an overview of the following:
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- Finances
- Income
- Debts
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Pre-qualification is helpful when shopping and comparing loan terms. However, it carries no weight as sellers and real estate agents don’t take it seriously.
Mortgage Pre-Approval Checklist
A pre-approval is a more detailed process. You need to fill out a mortgage application and provide your social security number. The lender will use this number for a hard credit check. Other requirements include:
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- Bank account information
- Assets
- Debts
- Income
- Employment history
- Past addresses
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With a pre-approval, the lender has checked and verified your documents in order to offer you an accurate loan amount. The specific loan amount that the lender offers you will hold for several months. So, you shouldn’t be surprised by higher rates or a lower loan amount when it comes time to take out your mortgage.
When To Get a Pre-Approval
Pre-approval letters are valid for 60-90 days. They have an expiration date because a buyer’s finances and credit profile may change over a longer period. If your pre-approval expires, you will need to fill out a new mortgage application with updated paperwork. You may not be able to get the same loan that you were offered previously.
It is advisable that you seek pre-approval six months to one year before a serious home search. This gives you time to address any credit issues identified and improve your financial standing if necessary. You will also have more time to save for a down payment and closing costs.
The Mortgage Pre-Approval Process
How long it takes to get pre-approved depends on your lender and financial complexities. If you’re lucky, you can get pre-approved within days or even hours of applying.
The application process involves filling out a mortgage application. This application is quite demanding, requiring your identifying information and social security number.
A mortgage application has eight main sections:
1. Type of Mortgage and Terms of the Loan
This section details the particular loan product you are seeking. It includes the loan amount and terms such as the loan repayment duration and interest rate.
2. Property Information and Purpose of the Loan
This section provides information on the relevant home and how the loan will be used. It includes the following information:
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- The address
- The legal description of the property
- Year of development
- Loan purpose (purchase, refinance, or construction)
- Intended type of residency (primary, secondary, or investment)
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3. Borrower Information
This section regards your identifying information, including
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- Full name
- Date of birth
- Social Security number
- Years of schooling
- Marital status
- Number of dependents
- Address history
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4. Employment Information
The contents of this section include:
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- The name and contact information of current and past employers
- Dates of employment
- Title
- Monthly income
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5. Monthly Income and Combined Housing Expense Information
This section includes:
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- Your base monthly income
- Overtime
- Bonuses
- Commissions
- Net rental income (if applicable)
- Dividends or interest
- Any other monthly income
- Monthly combined housing expenses
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6. Assets and Liabilities
Here, list your investments and debts, specifically:
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- All bank and credit union checking and savings accounts, including balance amounts
- Life insurance
- Stocks
- Bonds
- Retirement savings
- Mutual funds accounts and corresponding values
- Bank and investment account statements
- Liabilities and debts
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7. Details of the Transaction
This section is an overview of significant transaction details, including:
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- Purchase price
- Loan amount
- Value of improvements/repairs
- Estimated closing cost
- Buyer-paid discounts
- Mortgage insurance (if applicable)
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8. Declarations
Declare the following:
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- Any judgments, liens, past bankruptcies or foreclosures, pending lawsuits, or delinquent debts
- Whether you’re a U.S. citizen or permanent resident
- Whether you intend to use your home as a primary residence
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Next Steps and Documentation Needs
Your lender will provide you with a loan estimate. The law requires the lender to do so within three working days of receiving your application. The loan estimate is a three-page document that states if you have a pre-approval and outlines the following:
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- Loan amount
- Terms and type of mortgage
- Interest rate
- Estimated interest and payments
- Estimated closing costs (including any lender fees)
- An estimate of property taxes and homeowner’s insurance
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Once your application closes, your loan file goes to a loan underwriter. The underwriter will review all documents against the information on your mortgage application. They will ensure that you satisfy the requirements of each mortgage program.
There are many documents required for pre-approval. You also need to put together documents to verify the information you provided. The documents include:
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- Bank statement for the last 60 days
- Pay stubs
- Previous two years’ W-2 tax returns
- Schedule K-1 for self-employed borrowers
- Income tax returns
- Asset account statements
- Driver’s license or U.S. passport
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Factors Impacting Pre-Approval
It is essential that you understand what lenders assess in your financial profile. This information will help you maximize your chances for a pre-approval. These factors include:
Debt-to-Income Ratio (DTI)
Your DTI is the amount of monthly debt you have outstanding as a percentage of your monthly income. You typically need a DTI of 43% or lower to qualify for a mortgage. The lower your DTI, the lower the interest rates that you can qualify for.
Loan-to-Value Ratio (LTV)
The LTV is the loan amount divided by the home value. The best way to lower the LTV is to make a larger downpayment on the home as this lowers the loan amount.
If you are struggling to make a substantial downpayment, you may want to look into an FHA loan. These loans only require a 3.5% downpayment, meaning the FHA maximum loan-to-value ratio is 96.5%.
Credit Score
Lenders will review your credit history to see what kinds of credit lines you have open and if you consistently pay bills on time. They will also evaluate your credit score. You generally need a score of 620 or above to be approved for a mortgage.
Employment History and Income
Lenders will look at your past two years’ W-2 tax forms to ensure you have a stable enough income to commit to a mortgage. You will also have to show bank statements to prove that you have saved enough of your income to afford a down payment and closing costs.
If your financial standing is not strong enough to qualify for a mortgage that is sufficient and affordable for you, consider taking some time to pay off some debts or save money. This will put you in a better position to qualify for a loan and get a lower interest rate.
Pre-Approval Decisions
After reviewing your application, a lender makes any of the following three decisions:
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- Pre-approved: Congratulations! if you are happy with the terms of the mortgage offered, you can start shopping for houses within your budget.
- Denied outright: In this case, the lender needs to explain to you the reason for this decision. It’s also necessary that the lender provides sources to resolve the issues that led to the denial. You will likely have to take some time to improve your credit score or savings before applying again.
- Pre-approved with conditions: In this scenario, the lender may require that you provide additional documentation. You may also need to lower your DTI ratio by paying down some credit accounts. The condition could also include withdrawing from your 401k for the down payment.
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