Getting preapproved for a mortgage is a crucial first step in landing a contract for that house you've had your eye on. Sellers will take your offer more seriously, and preapproval can even lead to a smoother, quicker closing, making it a must-have in many markets where the best housing deals receive multiple offers. So don't risk missing out.
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Should you want to understand more about getting preapproved, we've included an in-depth overview of the benefits and process below. Let's dive in!
Preapproval vs. prequalification
Make sure you're getting preapproved, not prequalified. A prequalification is a basic review of your finances to determine if you would qualify for a mortgage. In general, a prequalification is based on unverified information you provide and does not include a credit check or any documentation; it is therefore not a firm guarantee of a loan.
Unlike a prequalification, a preapproval is essentially the same thing as applying for a mortgage, just without a specific home attached to it. As part of a preapproval, a lender will check your credit, verify your income and employment, and commit to lending a certain amount of money.
Upon obtaining a preapproval, you'll receive a letter stating that the bank is prepared to give you a loan for a certain amount. In addition to assuring you that credit and income won't be an issue later on, a preapproval lets sellers know that you're a serious buyer and won't just make an offer and disappear.
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Benefits of getting preapproved
- You'll know exactly what you can afford: One of the most frustrating things that could possibly happen in a home search is finding your dream house, then going to the bank only to be told that you can't afford it. By getting a preapproval, you'll know exactly what the upper end of your budget is, which will help you narrow down your home search before it even starts. One word of caution: Don't submit your original preapproval letter with your offer, especially if you are offering substantially below what you can "afford." This gives the seller more ammunition for negotiations. Most lenders will issue you a new preapproval letter for the exact amount of your offer (as long as it's under your preapproved maximum), so the sellers will have no idea of how much wiggle room you have.
- Sellers will take your offers more seriously: On that note, submitting a preapproval letter with an offer makes you a much more attractive buyer. Sure, your offer won't be quite as appealing as an all-cash offer, but you'll be taken a heck of a lot more seriously than a buyer whose offer is still contingent on mortgage approval. Your preapproval letter tells the seller that you want the house, and can actually afford to pay the amount you offered for it. It also says there is hardly any chance that you'll run into financing issues before closing.
- You can deal with problems before you're in a time crunch: If there is a problem with obtaining financing, it's much easier to clear it up before you're locked into a contract. Let's say your credit score is too low, and that it's due to an error on your credit report. Well, this can take a month or so to clear up, and if you plan to close on your house in 45 days, it can put you in quite the time crunch. On the other hand, if you go for a preapproval, you'll have all the time you need to deal with whatever issues you run into, before proceeding to the offer stage. Maybe you'll need to order old pay stubs from your employer's payment processor. Maybe you'll need copies of your 2012 tax return, which you've since misplaced. Or maybe you have a borderline credit score for approval, and paying down a few thousand dollars of your credit card balances would push you over the limit. The point is that any of these are easier to deal with when you don't have a deadline.
- It eliminates surprises after you choose a home: Because you have already submitted your income documentation, had your credit checked, and jumped through any other hoops in the mortgage process, you'll be in a position for a much smoother and quicker close than if you wait to start your application process until you find a house. The loan-closing process can take anywhere from two weeks to over a month from when you submit every piece of documentation the bank wants (and trust me, there can be a lot). However, if you've already done that, your lender can start getting your loan ready to go as soon as you have a signed contract, and you won't need to scramble for documentation.
What's required for preapproval?
The preapproval process is more formal and in-depth than a prequalification, so set your expectations appropriately, timewise, and be prepared to provide a number of materials during the approval process.
First, the lender will have you complete an official mortgage application, which may incur a fee. It's during this process that the lender will both require additional documentation and run a hard inquiry to pull your credit rating. Be sure to check your FICO score beforehand, and fix any potential issues so there aren't any surprises.
The application process will enable the lender to tell you the actual amount for which you are approved, as well as the interest rate charged. In short, provided documentation will enable the lender to determine your:
- Debt-to-income ratio
- Income and reasonable ability to repay a loan
- Credit score
Documents will vary by lender, but you can generally assume you'll need to provide comprehensive paperwork evidencing your income, assets, and liabilities. Here's a deeper review.
Proof of income: A comprehensive overview of your income is one aspect lenders will use to determine how much you can afford to borrow. You should be prepared to provide these items, at minimum:
- Thirty days of pay stubs that show income as well as year-to-date income
- Two years of W-2 statements
- Two years of federal tax returns
- Sixty days or a quarterly statement of all asset accounts including your checking, savings, and any investment accounts
- Any additional documents highlighting bonuses or alimony
Proof of assets: An overview of your assets helps prove that you have sufficient funds for a down payment and can pay closing costs. A lender will generally want to review the following:
- Three to six months of checking and savings account statements
- Three to six months of investment account statements
- Written documentation for other cash assets
Any and all deposits not linked to your payroll need to have written documentation proving the source of the funds. You may even want to deposit cash hidden under your mattress and be ready to provide written documentation as to the source of those funds.
Proof of liabilities: You'll need to report, and likely provide documentation of, any debts and liabilities, including things like credit card payments, car loans, or student loan debt.
Good credit: Low mortgage rates are typically reserved for borrowers with a credit score above 740. If you have a credit score below that, there are still options worth considering, such as an FHA (Federal Housing Authority) loan. An FHA loan is a type of mortgage where you pay fees to the Federal Housing Authority to guarantee the loan to the bank, thus allowing you to put less than 20% down.
FHA loans with a down payment as low as 3.5% are available to borrowers with a credit score of at least 580. Below that number, you'll be required to put down at least 10%. People with credit scores under 500 are likely ineligible for FHA loans.
Employment verification: Lenders will want to not only review pay stubs, but to verify their authenticity by calling your employer. If you've changed jobs recently, your lender will also want to call your previous employer. If you're self-employed, be prepared with comprehensive paperwork outlining your business income.
Other documentation: You will need to provide copies of your driver's license and Social Security card for the lender to pull a credit report.
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