When you’re serious about buying a home, one of the first steps you should take is getting a mortgage preapproval. It’s a relatively quick process that involves a lender pulling your credit and reviewing your financial situation to determine whether you qualify for a home loan and how much house you can afford.
You’ll need to give the lender several documents, including pay stubs, tax forms and bank statements, to verify your earnings, debts and assets. If you qualify based on that information, the lender will estimate the amount you can borrow and document it in a preapproval letter.
When you’re ready for preapproval, understanding how this step works and doing a little prep can be helpful.
Mortgage Preapproval vs. Prequalification
When you start researching mortgage rates, you may hear lenders use the terms preapproval and prequalification interchangeably. Both terms refer to a document that states a lender is tentatively willing to lend you up to a certain amount, based on information you provide. The key difference is whether the lender verifies that information.
Prequalification
A prequalification involves plugging some financial details into an online form or having an informal conversation with a lender. You’ll answer questions about your credit score and finances, and your lender uses that information to estimate your loan amount. “The lender doesn’t pull your credit report or verify your information to determine what you can afford,” says Melissa Cohn, regional vice president with William Raveis Mortgage.
The prequalification roughly estimates how much you can borrow and the interest rate you’ll receive, but it doesn’t carry the same weight as preapproval because the lender hasn’t verified your information.
Preapproval
A preapproval is more in-depth because “it says that the lender has put eyes on your tax returns, your W-2s, your paystubs, your assets, your credit — and verified the accuracy of the information you provided,” says Nicole Rueth, senior vice president with Movement Mortgage. This puts you into a position where you can set a realistic housing budget and negotiate a purchase contract with a seller.
The preapproval letter is usually good for 30 to 60 days to show an agent or a seller that you’re working with a lender. Sellers typically require you to include a preapproval letter with your purchase offer, so having one from the start can put you ahead of other buyers who don’t have one.
Just keep in mind it doesn’t guarantee you a loan — you’ll still have to go through the underwriting process later — and it’s not a binding agreement. You can still shop around for lenders once you select a house.
[Read: Best Mortgage Lenders]
How to Get Preapproved for a Mortgage
Understanding the mortgage preapproval process can help you prepare your finances for it. What to do:
Set a Budget
A lender can preapprove you to borrow a certain amount, but you may choose to borrow less. One way to set a monthly mortgage budget is by using the amount you’re currently paying toward housing. Or you can start fresh: Subtract all of your non-housing expenses from your take-home pay to estimate how much you can put toward a home loan.
Lenders do a version of this when checking your debt-to-income ratio, or DTI. Most lenders like to see that your combined debts equal less than 36% of your income before taxes, though you could be approved with a DTI of 45% to 50%.
Estimate your Down Payment
The minimum down payment you need depends on the type of mortgage you get and the lender’s requirements, and it can vary from 0% to 20% of the home’s purchase price. You can choose to put down more, but consider your other needs. You’ll also need to cover closing costs, and it’s a good idea to have cash reserves in the bank.
Check Your Credit
Your credit history and credit score are major factors in determining whether you’re preapproved and what interest rate you receive. You can pull a free report from each of the three credit bureaus weekly at AnnualCreditReport.com. Read through the reports and check for errors, such as incorrect account balances and duplications, and signs of potential identity theft, like new accounts you don’t recognize. You can dispute these errors and report identity theft to the credit bureaus.
If your score has room to improve, you can do so by paying down debt and making on-time payments every month.
Collect your Documents
Lenders will look at your credit history, income, assets and debts to see whether you should be preapproved for a mortgage. Before applying for preapproval, gather the following:
— W-2 forms from the last two years.
— Pay stubs from the previous 30 days.
— Tax returns from the last two years.
— Personal bank statements for the last two to three months.
— Identification, such as a driver’s license.
— Name and contact information for employment verification.
— Other forms of income verification, such as a Social Security award letter, alimony letter or pension pay stubs.
— Documents supporting your current housing arrangement, such as copies of 12 months’ worth of canceled rent checks or a letter from a family member that states an informal agreement.
— Divorce decree, if applicable.
The lender also pulls your credit scores and credit reports to check for current debts. When going through your bank statements, the lender “confirms you have the assets to cover your down payment and closing costs, then looks for additional debts that aren’t reporting to the credit bureaus,” Rueth says. These may include alimony, child support and payments for buy now, pay later services.
If you’re self-employed or you have other special circumstances, you will need more documents, such as:
— Business tax returns for the last two tax years.
— Business bank statements for the last two months.
— Year-to-date profit and loss statement. Some lenders require a CPA to sign the statement.
Contact a Lender
Make a list of lenders that operate in your state, offer the type of home loan you need and have a strong reputation. Call one of the lenders and ask any questions you have, such as the loans they offer and closing costs they charge. If you feel comfortable with the lender, ask for a preapproval. You can get more than one preapproval to shop for the best rate, but it depends on your situation.
“Getting several preapprovals could help you speed up the closing timeline if your offer’s accepted,” Rueth says. “I would do the work upfront. I wouldn’t want to wait until I’m under the gun and feel trapped.”
Get Preapproved
The lender will get consent to pull your credit and ask questions about your financial situation. They may ask you to upload your documents in an online portal or to email them. Once you have the preapproval letter, you can shop for homes within your price range and submit your purchase offer.
How Long Does It Take to Get Preapproved for a Mortgage?
The preapproval process can take 24 hours if you have the documents upfront, Cohn says. The time frame could stretch longer if you need to provide more documentation or during periods of high demand.
You can speed up the process by collecting all your documents before you apply.
How Far in Advance Should I Get Preapproved?
A prequalification is a good start if you’re simply curious about the rate and loan amount you may receive. But “as soon as you know that you’re going to start looking to buy a house, get preapproved,” Cohn says. “You’ll make sure that a) you can get preapproved, and b) if there are any issues that prevent you from getting preapproved, you have time to correct them.”
It’s especially important to take this step if you went through the preapproval process more than a year ago, when interest rates were significantly lower. “Even if you’ve been preapproved in the past, we’re in a very different lending environment,” Cohn says. “It’s important to get preapproved again.”
Do Mortgage Preapprovals Affect Your Credit Score?
A full preapproval comes with a hard credit pull, Rueth says, which can lower your credit score by a few points. The hard inquiry may stay on your credit reports for up to two years.
Credit-scoring companies know borrowers shop around for rate quotes, so there’s a way to reduce the impact of getting more than one preapproval or submitting several mortgage applications. Multiple credit checks from mortgage lenders over a 45-day window will count on your credit report as a single inquiry.
[Read: Best Mortgage Refinance Lenders.]
Improve Your Chances of Getting Preapproved
Take these steps to avoid being denied a mortgage preapproval:
— Fix errors on your credit report. Credit reports aren’t perfect, and errors that affect your score can happen. Find and fix errors on your credit report before you ask for a mortgage preapproval.
— Pay down debt. Debt can hurt your credit and is a factor in the loan amount you could receive. Eliminating as much debt as possible can put you in a better position for mortgage preapproval.
— Save more. Saving is a sound move for your finances, but it will also make you a better loan candidate in the eyes of the lender. Strive to tuck away at least three months’ worth of mortgage payments to help cover financial emergencies without going into debt. If you can save up to six months’ worth of your monthly expenses, that is even better in the long run.
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How to Get Preapproved for a Mortgage originally appeared on usnews.com
Update 12/06/23: This story was published at a previous date and has been updated with new information.
