After weeks or even months of online searching and home tours, you finally find your perfect house. Sure, it may need a little bit of sprucing up here and there, but it’s in your desired location and the layout is ideal. You can’t wait to make it yours! Before you make an offer, there’s a step you need to take first: getting preapproved for a mortgage loan. A preapproval is different from a prequalification, which you may already have.
Preapproval vs. Prequalification
Getting preapproved is almost like a promise from the bank for your loan. When you get preapproved, the mortgage lender will look at your income, perform a credit check, and provide you with an amount that you will be able to borrow for your home loan. This is as close as you can get to an actual mortgage, and there’s a time limit on the offer – usually 90 days. This is why you want to get preapproved just before you make an offer.
Prequalification is more like a general estimate. The lender doesn’t do a credit check for a prequalification, and you don’t have to provide proof of income. Typically, the prequalification comes at the very beginning of the home buying journey, during that “should I or shouldn’t I” phase. It is a discovery process: can I qualify? If so, about how much would I be able to borrow? What would my interest rate be? You can also get prequalified by more than one loan provider, allowing you to shop around for the best terms.
Once you’re prequalified, you’ll have a better idea of which mortgage lender you want to go with. You’ll get preapproved from that lender, and this is typically the same lender that will approve your final loan. Of course, once you’re familiar with the process, you may decide to go with a different lender. Before the loan is locked in, feel free to consider competing offers.
What You’ll Need for the Preapproval
Basically, the process for the preapproval is very similar to the one you’ll encounter when getting approved for your final loan. Generally, lenders will want your financial history for the past two years. This includes things like pay stubs, tax documents, and proof of residency. Information on your current assets and bank statements from any savings or investments are also required. Finally, you’ll be asked for a valid photo ID, such as your driver’s license or passport, and your social security number for a credit check.
While the process may be a little daunting, organizing your paperwork ahead of time will help you during the preapproval process. Here’s a basic list of what you might need when getting preapproved for your home loan:
Information for the federally required mortgage application:
- Your full name, date of birth, social security number, and phone number
- Number of children (if any), and their ages
- Your marital status
- Your residential history for the past two years. For renters, this includes the landlord’s name and the monthly rent. For homeowners, it includes mortgage, tax, and insurance information for all properties owned.
- Two years of employment history: companies, addresses, titles held, contacts
- Two years of income, including bonuses, commissions, and self-employment
- Account balances for all checking, savings, retirement, and investment accounts
- Current fixed debt, including credit cards, mortgages, car payments, alimony, child support, and student debt
- Documentation for any bankruptcies within the last seven years, any lawsuits, and any properties where you are a cosigner
- Whether or not a percentage of the down payment will be borrowed
Documentation required to obtain a loan:
- Written authorization for the lender to run a credit check
- Written explanations for anything derogatory in the credit report
- Discharge papers from bankruptcy if one occurred in the last seven years
- For renters, 12 months of canceled rent checks or a form confirming on-time rent payments from your landlord
- If you are a landlord, all applicable lease agreements and bank statements
- If you’re selling a home while buying, confirmation of the listing agreement
- 30 days of pay stubs
- Two years of W2 forms
- Two years of personal federal tax returns
- If you’re self-employed, two years of business tax returns
- Also for the self-employed, year-to-date profit and loss statement
- Divorce decree (if applicable) and documentation of child support and alimony payments
- Two months of bank statements from your checking, savings, retirement, and investment accounts
- If you’re receiving gift funds, a statement from the giver confirming it’s a gift and not a loan
Is It Necessary to Get Preapproved?
While you can submit an offer without a preapproval letter, submitting this letter with your purchase offer shows the seller that you’re a serious buyer and you already have the finances lined up for the purchase. This could give you an edge, especially in a competitive market. In addition, the preapproval gives you an idea of what your down payment, monthly mortgage payments, and your terms will look like. Instead of making an offer on what you think you can afford, having a preapproval letter shows you exactly what you are able to afford.
Since the mortgage lender will do what’s called a hard credit check for your preapproval, it will impact your credit slightly. But this small dip will bounce back within a few months. While it is best to have the highest credit score possible before applying for a mortgage, the preapproval benefits usually outweigh the potential (and temporary) minor drop in your credit score.
Before applying for your preapproval, you’ll want to know your credit score (also called a FICO score). Scores typically range between 300 and 850, and it’s used to evaluate the amount of risk the bank might face when giving you a loan. If you haven’t looked at your credit report lately, be sure to get it from annualcreditreport.com and make sure there isn’t any suspicious activity. If there is, you’ll want to clear that up before applying for a mortgage loan. Be aware that this report details your credit history, but it doesn’t give you a credit score. You should be able to get your score through your bank, credit card company, loan statement, or a credit score service. You can also ask a non-profit credit counselor for your score.
You will have more than one credit score. Depending on which consumer reporting company your mortgage lender uses, it may be different from what you have. This is because there are three major credit bureaus (Experian, TransUnion, and Equifax), and they all calculate scores differently. However, they are all usually within a few points of one another.
Once you know your score, here’s what it means:
- A credit score of 720 or above is considered excellent credit. You should easily qualify for a variety of mortgages with good interest rates and low fees.
- If your score is 680-719, you have good credit. You’ll likely qualify for a mortgage loan with a decent interest rate and standard fees.
- A score of 620-679 is considered fair. There’s a chance you’ll qualify but you’ll likely have fewer options and higher interest rates and fees.
- Poor credit ranges from 580-619. It may be difficult to qualify. Options will be limited, and your interest rates and fees will likely be high.
- A score in the 350-579 range is considered bad credit. If your score is in this range, you probably won’t be able to qualify for a mortgage, although there are some exceptions.
How to Find a Mortgage Lender
There are different types of mortgage lenders. Direct lenders, like banks and credit unions, are the most common type of lenders. They loan directly to you, the home buyer. You’ll likely work with one loan officer throughout the duration of the home buying process. Another type of lender is called a mortgage broker. Unlike a direct lender, the mortgage broker serves as an intermediary between you and a lender. A mortgage broker charges a small fee for this service, which is initially paid for by the lender but is ultimately passed on to you through the loan. The benefit of a mortgage broker is that they work with several different loan providers and will negotiate the best terms for your loan.
For those who can’t qualify for a traditional mortgage, hard money lenders could be an option, although this approach does involve some risk. Hard money lenders are private investors who are more interested in the value of the property than in your ability to repay the loan, so they aren’t as concerned with your credit score or income. However, they often require repayment within one to five years, and the fees can be quite steep.
If you’re not sure what type of lender you want or where to look, ask your real estate agent. They’ve likely worked with several loan providers in the past and can give you a recommendation. Your agent can even guide you through the preapproval process, answering your questions along the way.