Before visiting open houses and considering potential properties to purchase, it is common for potential buyers to first seek pre-approval for financing from a lender. This process usually involves filling out a mortgage application and providing necessary financial documentation. Many sellers expect buyers to have obtained pre-approval before entering into negotiations, as it demonstrates their ability to secure a loan for the purchase. As a result, obtaining pre-approval can often give buyers an advantage in the home buying process.
Pre-Qualification vs. Pre-Approval
When it comes to buying a home, obtaining a mortgage pre-approval is typically a more valuable step than getting pre-qualified. Pre-approval means that a lender has checked the buyer’s credit, verified their assets, and confirmed their employment, and has approved them for a specific loan amount. This approval is usually valid for 60 to 90 days.
On the other hand, a mortgage pre-qualification is more of an estimate of what a person might be able to afford based on their income and debts, and is not as reliable as a pre-approval.
Consulting with a lender, obtaining a pre-approval letter, and discussing loan options and budgeting can be beneficial for buyers. The lender will provide the maximum loan amount, which can help the home shopper set a price range for their search. A mortgage calculator can also be helpful for estimating costs.
Requirements for Pre-Approval
Obtaining a mortgage pre-approval is a crucial step for homebuyers. It requires the buyer to submit a mortgage application and provide evidence of their assets, income, and employment. A lender will then review the buyer’s credit score, debt-to-income ratio, and other factors to determine the maximum loan amount they are eligible for.
This pre-approval is typically valid for 60 to 90 days and can be helpful in setting a price range for the home search. There are various types of loans available, including ones designed for first-time buyers or low-income borrowers, as well as VA loans which do not require a down payment for eligible U.S. veterans and service members.
1. Proof Of Income
To be considered for mortgage pre-approval, a potential homebuyer will need to provide various financial documents to the lender. This may include wage statements, tax returns, pay stubs, and any other documentation that can help to verify the buyer’s income. This information is typically required to be provided for the past two years, and may include proof of additional sources of income such as alimony or bonuses. By providing this information, lenders can assess the buyer’s financial situation and determine their ability to take on a mortgage.
2. Proof of Assets
To apply for a mortgage, potential homebuyers must provide documentation of their income and assets, including W-2 wage statements and tax returns from the past two years, current pay stubs, and proof of additional income sources such as alimony or bonuses. Additionally, bank and investment account statements must be presented to demonstrate the borrower’s ability to cover the required down payment, closing costs, and cash reserves. The amount of the down payment, which is typically a percentage of the selling price, may vary based on the type of loan being sought. Borrowers may also be required to purchase private mortgage insurance (PMI) if they are unable to make a down payment of at least 20% of the purchase price.
3. Good Credit
A borrower’s credit score plays a significant role in their mortgage approval process and the interest rate they will receive. Most lenders require a FICO score of at least 620 for a conventional loan or 580 for a Federal Housing Administration (FHA) loan. The higher the credit score, the lower the interest rate. For example, someone with a FICO score of 760 or higher may receive a lower interest rate than someone with a score between 620-639.
This difference can have a significant impact on the borrower’s monthly mortgage payments. For example, on a $250,000 loan, a borrower with a FICO score in the lowest range (620-639) may pay $1,288 per month, while a borrower with a score in the highest range (760-850) may pay $1,062 per month, a difference of $2,712 per year. It is important for borrowers to be aware of their credit score and work to improve it before applying for a mortgage.
4. Employment Verification
For self-employed buyers, lenders will typically request additional information in order to verify the stability of their income and assess the financial strength of their business. This may include information about the nature and location of the business, as well as its ability to generate and distribute sufficient income to make mortgage payments. In addition to reviewing pay stubs and other documentation, lenders may also contact the borrower’s employer to confirm employment and salary.
5. Other Documentation
To be pre-approved for a mortgage, borrowers must provide personal identification and authorization for the lender to check their credit report. This includes a driver’s license, Social Security number, and other necessary documents.
Pre-Approval vs. Approval
After a borrower completes a mortgage application, the lender is required to provide a document called a loan estimate within three business days. This document outlines the pre-approved loan amount and maximum loan amount, the terms and type of mortgage, the interest rate, and estimates of interest and payments, closing costs, property taxes, and homeowner’s insurance.
The loan file is then reviewed by a loan underwriter to ensure that the borrower meets the guidelines for the specific loan program, leading to final approval. This occurs when the borrower has an appraisal completed for the home and the loan is applied to the property. If there have been no changes in the borrower’s financial situation since pre-approval, the borrower and lender can proceed with the closing of the loan.
What If You Don’t Get Pre-Approved?
After reviewing a mortgage application, a lender will either pre-approve the borrower, deny the application, or pre-approve with conditions. If the borrower is pre-approved, it means that they are likely to be approved for a loan after completing the necessary paperwork and providing additional documentation.
If the application is denied, the lender should provide an explanation and offer suggestions for improving the borrower’s chances of being approved in the future. If the borrower is pre-approved with conditions, it means that they may need to provide additional documentation or make changes to their financial situation, such as reducing debt, in order to meet the lender’s guidelines for approval.
Obtaining mortgage pre-approval is an important step for potential homebuyers as it allows them to understand their budget and loan options, and makes them more competitive in the home buying process. It requires submitting documentation such as proof of income, assets, credit score, and employment verification.
The lender will use this information to assess the borrower’s financial situation and determine the maximum loan amount and terms they are willing to offer. If pre-approved, the borrower can then move forward with the home buying process, including getting an appraisal and finalizing the loan.