One of the first steps when buying a house is getting pre-approved for a mortgage loan. As with many aspects of buying a home, the process may seem confusing or daunting, but having a little knowledge going into the process can help. Find out what pre-approval is, why it's important, and how to best get pre-approved for a mortgage home loan.
What is Pre-Approval for a Mortgage?
When applied to a mortgage loan, the term pre-approved denotes the maximum amount you're qualified to borrow at a specific interest rate. These amounts are subject to specific requirements, such as a property appraisal, and are a snapshot of your current creditworthiness. To start the pre-approval process, you complete a mortgage application in full. Then, the potential lender determines your creditworthiness by evaluating the financial aspects of the application and running your credit report.
Getting a pre-approval means that the lender is confident that you will be able to make future mortgage payments. It also denotes the lender's confidence in your ability to make an appropriate down payment as well as pay any closing and appraisal costs associated with buying a home with a mortgage loan.
Pre-Approval vs Pre-Qualification
These two terms are sometimes mistakenly used interchangeably. Pre-qualification is different from pre-approval in terms of mortgage loans.
Pre-approval comes with a written guarantee that generally lasts for 90 days, but a pre-qualification is nowhere near as formal. It's simply a process that can help you determine whether or not you're ready to apply for pre-approval. It generally involves meeting with a mortgage professional to discuss your financial situation and get a rough idea of the price range you can afford.
Why Is a Mortgage Pre-Approval Important?
Getting pre-approved for a mortgage home loan offers a sense of direction, which may relieve much of the anxiety associated with buying a new property.
Being pre-approved helps borrowers know roughly how much they can afford. This allows them to focus their search on homes within their pre-approved price range, and perhaps prevent the disappointment of falling in love with a home that's out of their budget.
Pre-approval also speeds up the rest of the home buying process once a borrower finds a property they want to purchase. To determine pre-approval for a mortgage loan, lenders run the financial analysis needed to secure the mortgage. With this step out of the way, borrowers can proceed with the mortgage loan origination process.
A final benefit of pre-approval is the legitimacy it provides to any offer you make on a property. Sellers can see that you are financially able to complete the purchase if they choose your offer, and that gives your bid more weight compared to one that comes in without a pre-approval attached.
Steps to Take Before Applying
Before applying with a lender for pre-approval, you should check your credit history and clean up your financial standing. Credit monitoring is a good practice all the time, whether you're buying a home or not, and can help even more when seeking loans or additional lines of credit. The steps you should take before applying for pre-approval include:
• Look for errors in your credit reports with all three major credit bureaus and make sure they are corrected
• Pay down revolving credit accounts, such as credit cards, until they carry balances of no more than 30% of their credit limit
• Resolve any late payments or overdue accounts
• Ensure you have at least two years of records showing a steady income, such as bank statements, tax returns, or pay stubs
By taking a proactive approach to your financial profile, you can improve your chances of being pre-approved for a mortgage loan and potentially increase the amount for which you're pre-approved.
Getting a Mortgage Loan Pre-Approval
The pre-approval process is relatively simple. For the most part, all you need to do is complete the mortgage application and provide the lender with all the documentation they need. This often includes:
• Personal information — such as a driver's license or passport — for identification; and your Social Security number so the lender can run a credit check.
• Proof of income for the last few years. This includes employment income verifications and documentation of additional sources of income — such as interest and dividend income, alimony and child support received, and benefits from retirement, Veterans Affairs, or Social Security.
• Asset information that documents additional resources you have at your disposal, such as investments, property, and any inheritance or trust fund.
Once you've completed and submitted the mortgage loan application and all the necessary documentation, the rest is up to the underwriter. While automated underwriters are becoming more popular and can provide a decision in as little as one day, the process generally takes anywhere from two weeks to two months. The average is around one month.
During this process, it's possible that you will have to provide additional documentation. Otherwise, this part is just a waiting game for borrowers.
Applying to Multiple Lenders
It's always a good idea to hedge your bets by applying to more than one lender. Lenders know that you're only trying to buy one property and understand your need to shop around for the best mortgage loan. It's best to do this all at once, or at least within 45 days of one another, so that your credit report only reflects a single hard inquiry, instead of taking the hit from several.
Remember: Pre-Approval Is Not a Guarantee
While pre-approval provides you with a relative amount of confidence that you're likely to be approved for a mortgage once you find a home, it's not a guarantee. Although it's rare, sometimes a pre-approval that went through without a hitch is later denied in the underwriting process. There are several reasons why this can happen.
Credit History Changes
One of the most common reasons a mortgage is denied after a pre-approval is a change in the borrower's credit history. This includes incurring additional debts and falling behind on payments. Throughout the mortgage loan application process, it's essential that you maintain your debt-to-income ratio. This means not opening any new accounts, keeping all open accounts current, and maintaining your employment status.
Lenders prefer a consistent work history that demonstrates a reliable steady income stream. Changes and gaps during the application process imply an instability that lenders frown upon.
Additionally, changes to the lender's guidelines or loan requirements can cause this sort of denial. For example, maybe the lender changed their minimum threshold for pre-approval from a credit score of 620 to 640. If a borrower has a credit score of 639, their pre-approval may be denied. Two guidelines that lenders commonly change — and can cause a denial after a pre-approval — are the debt to income guideline and the one that determines the amount of reserves a buyer needs.
Getting your financial situation in order and maintaining it are the best ways to get a pre-approval for a mortgage loan. A pre-approval lets you know what price range you should be focusing on when you're home shopping. Whether you choose to go with a lender's offer or not, getting pre-approved for a mortgage loan is a great way to prepare for homeownership.