What is a Mortgage Pre-Approval?
A pre-approval is generally a letter from a lender stating the lender’s preliminary determination that a borrower would qualify for a particular loan amount under that lender’s guidelines. The determination and loan amount are based on income and credit information. Most pre-approval letters are good for 60 to 90 days.
Why Should You Get Pre-Approved?
There are many reasons why you should get pre-approved. The most important reason is that you will get an accurate idea of how much you can afford. This can help to target your home search and ensure you only look at houses that are truly in your price range. A pre-approval letter also helps you prove to real estate agents and sellers that you’re a credible buyer and able to act fast when you find the home you want to buy. Some sellers might even require buyers to submit a pre-approval letter with their offers, though having a pre-approval letter does not guarantee that your offer will be accepted by a seller. A pre-approval letter can make you stand out in a competitive real estate market. If you make an offer on a house without a pre-approval, your offer may not be taken as seriously as an offer from another person with a pre-approval.
Why Should You Get Ready Before Approaching a Lender?
The best thing you can do to ensure a smooth loan application process from start to finish is to prepare yourself before you even get pre-approved. That means understanding what kind of real estate you can afford, what a lender will look for when you ask for pre-approval, and what you’ll need to provide once you find a home and secure a contract on the property.
What Details Are Required in the Pre-Approval Process?
A lender will generally start by asking for some basic information about you and your financial history. If you have a co-borrower, the lender will also need this information about them. Generally, a lender will then request your Social Security number and permission to pull your required credit report (and your co-borrower’s, if you have one).
You want to ensure you can prove you’ve been gainfully employed for at least a few months; most lenders want to see 30 consecutive days worth of paystubs, and it’s always advantageous to have more. If you’ve had some trouble keeping a regular income or job, it might be best to hold off on the house search until your earnings are more stable.
You also want to take a look at your credit history and your credit score. Many credit cards provide you with your FICO score on each statement. Tools Quizzle or Credit Karma can give you an estimate so you have a good idea what your score looks like, but they will not be completely accurate.
If your score is on the low end, don’t panic. You may still be pre-approved and qualify for a loan, but you’ll pay a higher interest rate.
You can also take steps to help boost that credit score before you ask for pre-approval:
If you have any debt, ensure you’re making all payments in full and on time.
If you use a credit card, don’t let balances roll over. Again, pay in full and on time.
Don’t open new lines of credit immediately before asking for pre-approval – and don’t close old accounts, either.
Avoid making large purchases on credit cards, or using the maximum amount of credit available to you before paying off your card (even if you do pay that balance off in full and on time).
It may take a few months before your credit score starts working its way to higher numbers. Stick with these actions and stay consistent. You’ll be rewarded with a better score and a lower interest rate when you do ask for pre-approval – which means you’ll pay less over time in interest.
What If You Can’t Get Pre-Approved?
Not everyone will get pre-approved for a mortgage, but there are a few things you can do to get better prepared for the financial responsibility of homeownership:
Work to improve your credit score. Your credit score is impacted by payment history, outstanding debt, the length of your credit history, recent new credit inquiries, types of credit used, and more. Generally a score of 720 and higher will get you the most favorable mortgage rates.
Correct any errors on your credit report, which could help to raise your credit score. The lender will analyze your credit report for any red flags, such as late or missed payments or charged-off debt. Even if you are deemed to have bad credit, there are ways to still get pre-approved for a mortgage.
Decrease your overall debt and improve your debt-to-income ratio. In general, a debt-to-income ratio of 36 percent or less is preferable; 43 percent is the maximum ratio allowed.
Increase your down payment amount in order to qualify for a larger loan.
Be sure to ask your lender for suggestions on how you can improve your chances of qualifying for a loan. They can tell provide you with tips on what to do in order to improve your credit score.
What Can You Actually Afford?
The most important thing to understand with mortgages is that a lender will almost always provide you a larger loan than you should reasonably accept. Once you know what they will approve you for, take that number and check it against your budget to make sure you can reasonably afford the monthly mortgage payment.
When house hunting, there are a few additional costs to keep in mind. Using these to work backwards to the list price of a home can help give you a more realistic idea if you can actually afford the home.
The estimated property taxes on the home
Any monthly or annual dues, like HOA fees
How much cash you’ll put down on the home (in other words, how much of the purchase price you’ll finance)
While lenders will provide loans with various percentages of cash down on the purchase, in most cases putting down 20% is a smart move if you have saved money for a down payment. The less you put down in cash on a property, the higher your monthly mortgage payment will be.
If you put down less than 20%, you’ll also have to pay a private mortgage insurance charge (PMI) which will mean paying an extra $50 to $300 per month (depending on your down payment and the purchase price of the home).
Research and Ask Questions
The best thing you can do for yourself before even looking at a real estate listing is to ask questions, seek out answers, and do your research. If you don’t understand something, speak up. Starting the process with the lender and getting pre-approval may prove to be beneficial so you don't start looking at homes you think you can afford, to find out you can't afford them.
If you have any questions or would like to speak with a lender, feel free to reach out to Shawn or Kyle and they can get you in touch with one of our lender partners we work.