Mortgage preapproval requires extensive documentation of your financial and credit history. Before house hunting, you should seek mortgage preapproval. Most real estate agents expect serious buyers to have one in hand. Read on as we explain what exactly mortgage preapproval is, what you need to secure it and what should be your next steps once you have it.
What Is Mortgage Preapproval?
In the housing world, you’ll encounter terms like mortgage prequalification and mortgage preapproval. Although they sound similar, they don’t refer to the same concept.
When you prequalify for a mortgage, a lender gives you an estimate of how much they think you can afford to borrow without defaulting. This decision is based on an overview of your financial and credit history. However, getting prequalified for a mortgage does not mean you’ve secured a loan. The next step is getting preapproved for a mortgage.
When a lender preapproves you for a mortgage, it tells you exactly how much it’s willing to loan you to pay for a home. That decision hangs on a thorough review and verification of your financial, credit and employment history. Your preapproval will come in the form of a letter. It may also contain an initial interest rate as well as terms of the loan.
Mortgage preapproval significantly boosts your chances in the housing market. For starters, most real estate agents expect you to be preapproved for a mortgage before you knock on their doors. Think of it as a seal of approval that tells agents you’re someone they can trust.
The entire process takes about two to four weeks. But some lenders claim they can approve you online within an hour. Regardless, mortgage preapproval requires certain documentation.
What Do You Need to Get Mortgage Preapproval?
Your lender will run a thorough search of your financials. To avoid any future headaches and expedite the process, have the following documents at hand:
Proof of identity: Gather your driver’s license or official state ID, passport, Social Security card and other documents that verify who you are and where your permanent residence is.
Proof of employment history: Most mortgage lenders require the last 30 days of pay stubs that also indicate your year-to-date income. Your lender may even call your employer to verify your employment status. Most lenders prefer to work with people who have steady employment. So if you recently changed jobs, you might decide to wait on mortgage hunting for a few months.
Tax information: Gather your last three federal and state tax returns along with your last three W-2 forms.
Credit score: Your credit score serves as one of the most important factors in determining your mortgage amount and interest rate. Lenders typically offer the best rates to people with credit scores of 740 or above. Generally, you’d need a credit score of at least 620 to secure an FHA loan — a type of government-backed mortgage that usually carries a smaller interest rate than a conventional mortgage. Lenders may still approve people with lower credit scores. However, they’d usually need to make larger down payments and take on higher interest rates than people with better credit. So, you may want to bump up your credit score as high as you can before you start searching for mortgage lenders. It’ll pay off in the end. You can find your credit score online for free. Many major banks also provide their customers with a free credit score through their websites.
Clear picture of your financial history: Your mortgage lender will take a deep dive into your cash flow down to the penny. Prepare yourself to provide recent bank statements from all accounts including checking, savings and investing accounts of any kind. Remember, your lender wants to get a crystal clear picture of your debt-to-income ratio to determine what you can afford to pay back. Therefore, you’d also need to provide your lender with documentation of all your bills and financial obligations.
Documentation of irregular income: Here’s where it may get a bit tricky. You’d need to explain any sudden, major deposits outside your regular paycheck. These deposits may raise some red flags with your lender. In fact, government regulations are significantly strict when it comes to what you can and can’t use to pay off your mortgage. But don’t fret. Maybe you’re getting help from family members to make your down payment. If you recently graduated or married, you may have told friends and family to make monetary gifts to help you fund your new home. Reach out to these people and ask for short letters indicating they made gifts to you and don’t expect to be paid back. Furthermore, you’ll need to provide documentation of any additional income such as bonuses or alimony payments. Overall, keep a record of all money coming in.
Self-employment income: You’d need to provide extensive documentation of your income if you file as a freelancer or independent contractor. This includes sole proprietors, partnerships and S-corporations. You’d need to provide at least three years worth of Form 1099s. You’d also need to present a year-to-date profit and loss statement.
Real estate income: If you’re earning income from any property, you’d need to provide specific paperwork. Examples include a lease and documentation of rental income for the last three years. You’d also need to prove the current market value of the rental property.
Shop Around Before Getting Preapproved for a Mortgage
Do your homework. Hundreds of mortgage lenders around the country want your business. And despite tight regulations, not all are going to offer you the best mortgage rates and terms. So shop around and don’t worry about how the search will affect your credit score. Generally speaking, any inquiry into your credit history by a firm scratches a little off your credit score. But according to a recent report by the Consumer Financial Protection Bureau (CFPB), every credit score check from a mortgage lender within a 45-day window counts as one search.
Know the Real Costs of a Mortgage
Before you go house hunting, know exactly how much house you can afford. Financing a home can be a 30-year commitment, so make sure you’re ready to handle it. Furthermore, lenders require down payments before your mortgage kicks in. Down payments typically range from 3.5% to 20% of the home’s value. For example, consider a home worth $200,000. If you’re making a 20% down payment, you’ll need to pay $40,000 up-front.
When it comes to a mortgage, a monthly payment doesn’t typically break down into just what you pay in interest and what you pay off the principal — the amount you initially borrowed. Additional monthly requirements can come from property taxes, homeowners insurance to protect the property from hazards like fires, private mortgage insurance, and homeowners association fees. Be sure to ask your lender about all about fees and payments of any kind. Also, keep in mind that you’d need to have a strong emergency budget to fund unexpected home maintenance expenses.
You’ll also have to pay closing costs. These payments may include application and administrative fees as well as title fees and lender origination fees. You may owe attorney’s fees in states requiring lawyers present at real estate transaction closings.
What to Do After You Get Preapproved for a Mortgage?
After a lender preapproves you for a mortgage, the road toward your dream home continues. Remember, you got preapproved because you demonstrated your trustworthiness as a responsible borrower. But if you fail to maintain that reputation, you can face some serious consequences.
Your lender may reduce the amount you can borrow, raise your interest rate or revoke the preapproval if you fail to maintain a good financial standing. That means don’t make any huge purchases without running it by your lender first. Lenders keep their eyes on your debt-to-income ratio. So avoid taking on new large debt.
In addition, avoid opening any new lines of credit. Each credit inquiry will knock down your credit score and change your credit capacity. Your lender may also get suspicious of your financial standing if you suddenly have the potential to rack up even more debt.
Instead, focus on paying off your current debt and keep paying bills on time to boost your credit score. A different lender may take notice of your improved credit score and offer you a better interest rate.
Once you’ve found a home you’re ready and able to commit to, your lender will move your mortgage preapproval onto the final application phase. The loan finalizes when an appraisal is done of and your mortgage is tied to a particular property.
What If You Don’t Get Preapproved?
Don’t panic if a lender rejects your mortgage application on the first run. Look into a different lender or ask for your mortgage application to be reviewed by someone else in the firm that turned you down the first time.
If the lender gives you a second chance, prepare to defend your case. Maybe a rare blow to your finances such as an unforeseen medical expense crippled your chances at securing a mortgage. Draft a well-written letter explaining this as a one-time event that shouldn’t overshadow your otherwise solid financial foothold.
But if you still don’t manage to get preapproved for a mortgage, you may need to make some changes to your financial situation. Take it as an opportunity to improve and better yourself. Maybe you need to cut back on unnecessary expenses or develop a better budget. Maybe you need to develop a better savings strategy or tackle other debt. In the end, you may walk away with a financial wellness and a mortgage with a much more manageable interest rate.
Most real estate agents expect you to be preapproved for a mortgage before they even open the door. The process may seem extensive, but preapproval tells sellers you’re a serious buyer and you mean business. So gather all your paperwork, shop around for lenders and get ready to step into your dream home.
Tips for Getting Mortgage Preapproval
- Rates can vary extensively for different mortgage terms. Factor your monthly payment for common types like 30-year fixed-rate mortgages, 15-year fixed-rate mortgages, 7/1 ARMs and 5/1 ARMs to see which is more manageable.
- There’s more to financing a home than just a monthly mortgage payment. So consider how all related costs affect your budget. Calculate down payments, closing costs and property taxes in your area.
- Mortgage preapproval requires extensive documentation of your income as well as your credit and employment history. So have a mortgage preapproval checklist by your side.
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