Mortgage pre-approval may seem like an intimidating process — but it doesn’t have to be! In fact, it’s a pivotal step that can help you determine a responsible budget and stand out when making an offer on your dream house.
Here are some insights, courtesy of Edina Realty Mortgage, that you can use as you get pre-approved for a home loan.
What is a mortgage pre-approval, and how does it differ from pre-qualification?
Pre-approval and pre-qualification are the two most common preliminary steps in applying for a home mortgage loan. But they each have different steps and benefits.
A mortgage pre-approval is the most comprehensive step a buyer can take toward attaining a home mortgage. To get pre-approved for a mortgage, the buyer will submit an official mortgage application and document their financial history for their lender.
The lender validates the borrower’s financial and credit information, then provides the buyer with a pre-approval letter that offers a qualified estimate of the loan amount for which the buyer is likely to be approved. The lender may also provide the estimated interest rate the buyer can expect, should current rates hold.
In short, a home loan pre-approval can offer the borrower peace of mind as they determine their budget (and buying power). And because sellers and their agents recognize the effort it takes to get pre-approved for a mortgage, they may take buyers with a pre-approval letter more seriously. In a multiple offer setting, sellers and their agents may not even consider an offer that doesn’t come with a pre-approval letter.
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You may also have heard of getting pre-qualified on a loan. This is an alternative (and less official) step that some buyers take in order to determine a rough estimate of their buying power.
In this quick and automated process — which can usually take place online or over the phone — borrowers will submit the following to a lender:
- Annual income
- List of assets
- Accrued debt
The lender will then return a general evaluation of the amount the buyer will likely be approved for on a home mortgage loan. This amount is mainly for the buyer’s personal reference; unlike a mortgage pre-approval, a pre-qualification is not strong evidence of the buyer’s loan potential for sellers and sellers’ agents.
What’s the smarter step: Mortgage pre-approval or pre-qualification?
If you’re trying to decide between getting pre-qualified or pre-approved, we recommend that you get pre-approved for a mortgage. It takes a bit more time, but provides a much larger benefit once you begin the home buying process.
What’s wrong with getting pre-qualified?
A pre-qualification is essentially an estimate, based off your “best guess” of information, which hasn’t been verified by the lender. That is to say, it’s not very accurate and it doesn’t hold weight with sellers or lenders once you decide to make an offer.
In the worst-case scenario, a buyer acting from an inaccurate pre-qualification may search or bid on homes in a higher bracket than they can truly afford. They may either be turned down by the seller, who chooses to go with a pre-approved (and therefore, more stable) buyer — or they may be denied by the lender once their loan application is submitted in earnest.
Why is getting a pre-approval better?
Alternatively, a buyer who is pre-approved can feel confident that (assuming their finances and employment don’t drastically change during their home search), they are able to search and bid for homes that are priced within their budget.
While getting pre-approved doesn’t automatically mean your offer will be accepted, it does signal to the seller and their agent that you are a serious buyer who has taken comprehensive steps to get pre-approved for a specific loan amount.
What do I need to get a mortgage pre-approval?
Homebuyers who hope to be pre-approved will be asked to provide documents and records related to their employment, credit, savings and more. Here’s a list of what you can expect to hand over to a lender; keep in mind your lender may ask for additional documents.
1. Income and employment records
Whether your income stems from a traditional 9 to 5 job, alimony or child support, freelance wages, rental property payments or a combination of sources, you’ll need to document it clearly to your lender.
When getting pre-approved for a mortgage loan, bring:
- Your last two tax returns
- W2 statements for the last two years
- Recent pay stubs
- Clear records of any other income sources
Lenders will want to double-check your employment, so you will also want to provide the name and contact information for your current employer or employers. If you are self-employed, you may be asked to provide additional documents that can help verify that your income is stable enough to support long-term mortgage payments.
2. Cash to close
Your lender will also want to verify that you have enough money for your down payment and closing costs — and that you will still have some cash on hand even after you attend and pay for your closing. Be sure to have proof of the money you have waiting in savings or investment accounts for these purposes.
If you plan to use mortgage gift funds, you will need to provide your lender a letter documenting the donor’s intent and the sum they wish to contribute.
3. Other personal, financial information
In addition to reviewing the above documents, your lender will dive deeper to review your full financial history and credit history. To do so, they may need:
- Driver’s license
- Social security number
- Access to your bank accounts and investment accounts
- Your signature to order your full credit report for review
And of course, you’ll also fill out a full mortgage loan application to submit to your lender.
What happens during the pre-approval process?
During the pre-approval process, the mortgage loan officer will review all the documents provided — from the credit report, to employment history, to tax returns, to the borrower’s checking and savings accounts — to ensure that the borrower is capable of taking on a home mortgage loan.
The lender will take special care to calculate the borrower’s debt-to-income ratio, which signifies the homebuyer’s ability to pay their mortgage in addition to any other debts they’ve accrued or bills they are required to pay monthly.
The lender will also evaluate which loan programs the borrower is eligible for. If the buyer has a higher down payment, they may be a candidate for a conventional loan, while borrowers who don’t have much saved up — but who have enough to pay a mortgage each month — may be guided toward an FHA loan. Veterans may be best served by a VA loan.
Once the lender has verified that the borrower has met their criteria, they will issue a pre-approval letter to the borrower.
What is included in the mortgage pre-approval letter?
If everything checks out after lender examines the credit and financial information you provide, a mortgage pre-approval letter is issued to you, real estate agents and home sellers.
This letter explicitly indicates that you have acceptable credit to be approved for a home mortgage loan, and how much you can borrow — assuming there are no major changes to your financial or credit history and that rates remain steady.
Your pre-approval letter may also contain the loan program and interest rate for which you’ll be approved, again assuming that there is no change to interest rates or your finances in the short-term.
Why would my pre-approval be declined?
If a pre-approval is declined, it could be because the borrower:
- Has too much debt and the lender doesn’t feel they are able to responsibly pay a mortgage over the long-term.
- Has a low credit score or a short credit history.
- Has a short or unstable history of employment.
- Does not have enough cash on hand to support a healthy down payment or closing costs.
Or, it may be something more specific that the lender can share with the hopeful borrower. In that case, the borrower can work to rectify the issues and re-apply when they are ready.
What steps can I take to be pre-approved for the highest amount?
Your financial and credit history determines your loan pre-approval. So, you might be approved for a better home loan if you can:
- Put more money down (either by digging deeper into savings or by receiving a mortgage gift fund)
- Raise your credit score
- Add a co-borrower with a stronger financial history
But remember, getting a home mortgage is a long-term financial responsibility and your lender is there to help ensure you aren’t taking on a larger burden than you can handle. So if your loan pre-approval comes out lower than you were hoping, it’s important to readjust your expectations and begin searching for homes that fit responsibly within your budget.
Key points and next steps
Interested in starting the home loan pre-approval process? Get connected with a mortgage loan officer to begin the pre-approval process.