Are you considering buying a home but don't know how much of a mortgage you'll qualify for? Getting a mortgage preapproval for a home loan often signals what size mortgage you can reasonably expect upon approval. However, as is true of taking out any loan, you should know a couple of things about how to get preapproved for a mortgage.
What Is Mortgage Preapproval?
Knowing how to get preapproved for a mortgage begins with understanding what preapproval means. Based on your overall financial health, preapproval determines whether you may qualify for a loan and how much that loan will be. A preapproval can also help show sellers that you're serious about buying.
Once preapproved for a specific loan amount, you can use your preapproval to shop for a home up to that amount. Once you have your preapproval, it's best to avoid taking out additional lines of credit or making large purchases during the homebuying process. This will affect your debt-to-income ratio (DTI), which can affect your loan amount — but more on that later.
Mortgage Preapproval vs. Getting Prequalified
You may hear the terms "prequalified" and "preapproved" used interchangeably. However, there is a difference between the two. During mortgage preapproval, your lender will pull your credit report and may request financial documents from you — the same as any other loan process. That's not the case when you prequalify for a home loan.
Prequalifying for a mortgage is the first step to getting preapproved. To prequalify, you supply your lender with information about your income and employment. Many lenders will run a soft pull credit report. This type of report provides the basics about your credit and outstanding debt but does not impact your credit score. After evaluating the information you provide, your lender is likely able to estimate how much of a mortgage you will qualify for.
A mortgage preapproval, on the other hand, takes a step beyond prequalification to include a standard credit report and possibly some verification of information your provided. When shopping for a home, a preapproval is preferred by realtors and sellers.
How Mortgage Preapproval Benefits You
Like with other types of loans, mortgage preapproval streamlines your home loan application process. It makes opening the doors of your new home easier and faster. With the initial paperwork and review out of the way, your lender knows what how much you could qualify to spend on a home. However, this can change during the final review if your financial situation changes, such as if:
- You change jobs.
- You apply for another line of credit.
- You make a large purchase.
- Your income changes.
Changes like these can affect your debt and income, which are essential when determining whether a specific mortgage payment will be affordable for you (there are other changes that can affect your approval process as well).
How To Get Preapproved for a Mortgage
Buying a home in today's market is sometimes challenging. These eight steps will guide you on your journey to homeownership and increase the likelihood of a successful mortgage preapproval.
Step 1: Check Your Credit Score
Know your credit score. As with other lines of credit, the better your score, the better your chances of approval. FICO credit scores — the kind most lenders use — range from 300 to 850. It's important to know what score your lender requires for the program you are interested in.
Step 2: Understand Your Credit History
Your credit score is part of your overall credit history and helps determine the interest rate for which you might qualify. Your credit history also reflects any outstanding debt and how well you manage debt.
Step 3: Know Your DTI (Debt-to-Income Ratio)
Lenders compare your monthly debt to your monthly income to determine whether your mortgage is affordable. Therefore, it's best to keep your DTI — which represents what percentage of your income goes toward your housing and recurring debt obligations — as low as possible.
Although your credit report won't specifically tell you your DTI, you can calculate it yourself or your lender can help you understand it. Another option is to use an online DTI calculator. It's best to speak with your lender, though, as some online calculators might not give you the full picture.
Step 4: Pay Down Debt
You don't need perfect credit for mortgage preapproval. However, it's a good idea to pay as much debt down as possible before applying for a mortgage, especially if you have a lot. In addition, a cleaner credit history and a higher credit score might help you get a lower interest rate.
There is no one-size-fits-all debt elimination method. Ultimately, deciding which approach makes the most sense for you is best.
Step 5: Save a Down Payment
For most mortgages, you'll need at least a 20% down payment to avoid paying private mortgage insurance (for conventional loans) or mortgage premium insurance (for FHA home loans). The idea behind both is similar. Lenders use private mortgage insurance and mortgage premium insurance to protect themselves against loss. PMI and MPI protect your lender if you default on your home loan.
This doesn't mean you need to put down 20%, but it's something to be aware of. In any case, you'll want to have funds set aside for when you're ready to put in an offer on a home.
Step 6: Prepare for Closing Costs
It's hard to pinpoint how much your closing costs will be since each state and situation differ. However, you can reasonably expect your closing costs to be between 2% and 5% of your home's purchase price.
Closing costs can include loan origination fees, property taxes, real estate commissions, attorney fees and discount points, and other costs. The seller may pay some of these fees, but as a buyer you will pay the rest.
Step 7: Have Earnest Money Saved
Earnest money is typically a deposit of 1% to 3% of your home's value, though it may be as high as 10%. This good faith deposit goes to the seller. It shows the seller and the seller's agent that you're serious about buying the home.
When you provide this good faith deposit, you'll sign a contract outlining the buying conditions and any contingencies. Should the seller break the terms of the agreement, the seller risks losing the earnest money. Additionally, the amount of the earnest money applies toward the down payment of the home.
Step 8: Provide Documentation for Mortgage Preapproval
There are many documents your lender will need for a mortgage preapproval, but here are some of the most important:
- Proof of income
- Two months of bank and financial statements
- Government-issued identification
- Personal information
- Property information, including a purchase contract
Your lender will advise you of anything else they need. However, to ensure a smooth mortgage preapproval process, provide all required documentation as soon as possible.
A mortgage preapproval is an important step to buying a home. By taking the time to understand what preapproval entails and gathering all of the necessary documentation, you can increase your chances of being approved for a mortgage. Speak with an expert to find out more.