How to get pre-approved for a mortgage
With mortgage pre-approval, a lender checks your credit and assesses your income, debt, and asset details using documents, including pay stubs, personal bank statements, and your federal personal income tax returns.
The lender uses this information to determine if you are pre-approved and how much mortgage you can receive. To reduce the risks associated with the COVID-19 pandemic and the economic downturn, lenders are typically tighten eligibility standards for all borrowers and intensification of the independent borrower income verification process.
Understanding these changes and doing a little prep work can help you when you’re ready to apply for pre-approval.
Mortgage pre-approval vs pre-qualification
During the mortgage application process, you may hear the terms “pre-approval” and “pre-qualification” used almost interchangeably. Both refer to a letter stating that a lender is ready to give you a loan and is confident that you have the resources to pay off a mortgage, but these are two different things.
“A prequalification is just a quick snapshot of a borrower’s financial situation, with mostly verbal information they provide,” says Paul Wendland, mortgage banker at CenterState Bank Mortgage. “A pre-approval goes a bit deeper. We actually get the official income documents and asset information, such as bank statements and retirement accounts, and we look at their credit in more depth.”
You’ll want to pre-qualify when shopping for mortgage lenders because pre-qualifying will give you an idea of the loan amount, interest rate, and other terms you might expect. Pre-approval gives you a clearer idea of these terms because it is based on a more comprehensive review. When you are sure that you have found good deals with a few lenders, you should go ahead with mortgage pre-approvals.
Getting pre-approved is “crucial,” says Trent Davis, associate real estate broker at Coldwell Banker Residential Real Estate – Florida. “If you find the property you’re looking for, a seller won’t largely consider your offer until you can provide a pre-approval letter.”
It also helps you troubleshoot potential issues with your application and find a home you might be approved to buy, Davis adds.
The pre-approval letter usually includes an estimate of your loan amount, interest rate, and monthly mortgage payment.
While a pre-approval puts you ahead of other buyers who don’t have one, it’s not a commitment from the bank. At the same time, it also doesn’t tie you to a particular bank’s mortgage, so you can use the pre-approval letter to shop around for around 30-60 days.
How to get pre-approved for a mortgage
Understanding the mortgage pre-approval process can help you prepare for your finances. Here are the steps to follow:
Make a plan. Figure out how much you can afford to pay on a loan each month before the lender makes their recommendation.
The amount for which you are pre-approved depends on your debt to income ratio. Most lenders like to see your combined debts be less than 36% of your gross income, your pre-tax income, although you can be approved with a DTI of 45%. However, only you know how much you are comfortable spending each month.
Lenders generally approve borrowers with less debt. The average borrower had an average back-end DTI ratio of 35% in spring 2020, down from 38% at the same time last year, according to a May 2020 Report from mortgage software company Ellie Mae.
To take out a mortgage, you’ll also need the funds to make a down payment. A 20% down payment is generally recommended for a conventional mortgage, but this amount may not be required. You will likely have to pay the closing costs, which are usually around 3% to 5% of the loan amount.
Check your credit reports. Your credit history and credit scores are major factors in determining whether you are approved and what interest rate a lender charges you. The healthier your credit, the more likely you are to get approved at a good rate.
Some mortgage lenders have increased their credit rating requirements to shore up risk during the COVID-19 pandemic. In the Ellie Mae report, the average credit score of all mortgage applicants was 750 in May, up from 728 in the same month in 2019. Requirements vary by lender.
If there is room for improvement, you can increase your credit score by paying off your debts and making payments on time every month. Until April 2021, you can view your credit reports each week free of charge with each of the three credit bureaus at: AnnualCreditReport.com.
Collect your documents. Lenders will check your income, assets, debt, and credit history to see if you should be pre-approved for a mortgage. Gather the following items before applying:
- W-2 forms from your employer for the two previous years
- Current pay stubs
- Federal personal income tax returns for the previous two years
- Personal bank statements for the previous two months
- Identification, such as a driver’s license
Documentation requirements are temporarily higher for independent contractors and self-employed workers, who often have less stable incomes. Independent borrowers may also be required to provide:
- An audited profit and loss account that presents the company’s income, net income, expenses and debts
- Business bank statements for the previous two months
- A tax return for the most recent year
Look for different lenders. Paying off a mortgage can take years or even decades, so know your lender before committing. Look up the lender and manager in the Consumer Financial Protection Bureau’s complaints database and with the Better Business Bureau. Talk to lenders about their loan closing schedule and ask all your questions, taking notes on your customer experience.
Request pre-approval and compare offers. You can request pre-approval after using pre-qualification to narrow down your options to a few lenders with the best rates and fees. With the solid offer of pre-approval, you may be able to negotiate better terms by pitting lenders against each other.
“I would suggest getting pre-approved through a lender and taking it to someone else and saying, ‘Hey, can you beat that? “” Davis says. A small difference in interest rates can make a substantial difference in the amount you pay over 30 years.
How long does it take to get pre-approved for a mortgage?
The pre-approval process can take one to three days, but the time can stretch longer during times of high demand, when lenders are pressed for time. It also depends on the time required to collect the documents. Speed things up by putting everything together before you apply.
Once you are on the phone with a lender, that lender will use an automated underwriting system to analyze your documents and get your credit.
Do Mortgage Pre-Approvals Affect Your Credit Score?
Getting pre-approved for a home loan can lower your credit score by a few points because the lender puts a lot of pressure on your credit reports during the process.
However, if you shop around and multiple lenders check your credit over a 45-day period, the credit bureaus generally count these requests as one credit draw.
Improve your chances of being pre-approved
There are ways to tip the scales in your favor when looking for mortgage pre-approval. A borrower “might have the income, but something about their credit is preventing them from being able to go ahead with the mortgage,” Wendland says. “If they get rid of it first, it gives them a clear path to buy their house.”
Here are a few ways to get your way:
Correct the errors on your credit report. Credit reports are not perfect and errors can occur that affect your score. Find and correct errors on your credit report before you apply for mortgage pre-approval.
Pay off the debt. Debt can hurt your credit and is a factor in the loan amount for which you can be approved. Eliminating as much debt as possible can put you in a better position for pre-approval for a mortgage.
Pay off your savings account. Financial emergencies can happen to anyone without warning. Saving is a good decision for your finances, but it will also make you a better candidate for loans in the eyes of the lender.
Keep at least three months of mortgage payments to help you deal with financial emergencies without going into debt. And if you can save up to six months on all of your monthly expenses, such as your mortgage, car payment, groceries, and utilities, that’s even better in the long run.