Getting pre-approved for a mortgage may be a vital step in the home-buying process. This phase can help you to define your overall house-hunting budget and the monthly mortgage payment that you can afford. Consulting with a lender and receiving a pre-approval letter gives you the opportunity to discuss loan alternatives and budgeting with the lender.
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| Pre-approval for a Mortgage: How to Do It |
Knowing what a mortgage pre-approval does (and doesn't do) and how to increase your chances of receiving one are crucial for borrowers.
A financial physical is what pre-approval is to you
Lenders will consider many essential variables before deciding to pre-approve you for a mortgage:
- DTI (debt-to-income) ratio
- LTV (loan-to-value) ratio
- History of credit
- FICO Score Earnings
- Work experience
Consider a mortgage pre-approval to be a financial physical. In an effort to make sure that you'll be able to repay your mortgage, lenders will probably probe and prod at every aspect of your financial life.
Comparing pre-qualification and pre-approval
Pre-qualification and pre-approval are two different things, despite the fact that you've probably heard the terms used interchangeably. A pre-qualification provides a mortgage lender with an overview of your finances, income, and debts. A projected loan amount is then provided to you by the mortgage provider.
A mortgage pre-qualification might serve as an estimate of how much you can afford to spend on a property in this way. The lender, however, does not get your credit records or check your financial facts. As a result, pre-qualification is a useful beginning point for determining what you can afford but has no bearing when making bids.
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| Pre-approval for a Mortgage: How to Do It |
A pre-approval, on the other hand, entails filling out a mortgage application and supplying your Social Security number so that a lender may run a rigorous credit check. When you apply for a mortgage, you will be subjected to a rigorous credit check. Before lending you money, a lender will retrieve your credit record and credit score to analyze your creditworthiness. Your credit score may be impacted by these checks, which are noted on your credit report.
A soft credit check, on the other hand, occurs when you pull your own credit or when a credit card provider or lender pre-approves you for an offer without your asking. Your credit score is unaffected by soft credit checks.
You'll also include all of your bank account information, assets, obligations, income, job history, previous addresses, and other crucial factors that a lender will need to verify. The reason for this is that a lender wants to guarantee that you will be able to repay the loan. Your DTI ratio and LTV ratio, which are crucial variables in establishing the interest rate and optimum loan type, are calculated by lenders using the information you have given.
Because of this, pre-approval is far more useful than pre-qualification. It indicates the lender has investigated your credit and validated your papers in order to authorize a specified loan amount. When an appraisal is performed and the loan is applied to a property, the loan is finally approved.
Obtaining a Pre-approval When:
Typically, mortgage pre-approval letters are good for 60 to 90 days. Because your finances and credit profile may change, lenders include an expiration date on these letters. When a pre-approval expires, you must apply for a new mortgage and provide new documentation to renew it.
Going through the pre-approval process might help you detect credit issues and possibly allow you time to solve them if you're just beginning to consider purchasing a home and fear that you could have some difficulties securing a mortgage.
You're better positioned to raise your credit score if you apply for pre-approval six to a year before you start a serious property hunt. You'll also have more time to save for a down payment and closing fees.
A seller frequently requests to see a mortgage pre-approval and, in certain situations, evidence of money when you are ready to make bids to demonstrate that you are a serious buyer. Sellers may be less willing to entertain bids without pre-approval letters in many hot property markets when there is a disadvantage due to high buyer demand and a dearth of available houses.
Procedure for Pre-approval
Mortgage applications may be exhilarating, nerve-racking, and perplexing. Some internet lenders can pre-approve you in a matter of hours, while others might take several days. The time frame is determined by the lender and the intricacy of your financial situation.
To begin, you will complete a mortgage application. You'll give your contact information as well as your Social Security number so that the lender may check your credit. Although mortgage credit checks are recorded as hard inquiries on your credit reports and may lower your credit score, if you shop around with several lenders in a short period of time (about 45 days for more recent FICO scoring models), the combined credit checks only count as one inquiry.
A sample of a consistent mortgage application is shown below. If you apply with a spouse or other co-borrower whose income is required to qualify for the mortgage, both applicants must provide financial and job information. A mortgage application is divided into eight stages.
Mortgage Type and Loan Conditions
The loan product for which you're applying; the loan amount; terms such as the length of time it will take to repay the loan (amortization); and the interest rate.
Property Specifics and Loan Purpose
The address, the property's legal description, the year it was built, whether the loan is for a buy, a refinance, or new construction, and the anticipated kind of residency-primary, secondary, or investment-are all required information.
Information about the Borrower
Information that may be used to identify you, such as your complete name, birth date, Social Security number, the number of school years you attended, if you were married, how many children you have, and previous addresses.
Information on Employment
Present and past employers' names and contact information (if you've been at your current work for less than two years), dates of employment, job title, and monthly salary.
Monthly Income and Housing Expenses
Overtime, bonuses, commissions, net rental income (if applicable), dividends or interest, and other forms of monthly income, such as child support or alimony, are all listed.
Additionally, you will require a breakdown of all of your monthly housing costs, including rent or mortgage payments, homeowners and mortgage insurance, real estate taxes, and homeowners dues.
Resources and Obligations
A listing of all checking and savings accounts with current balances at banks and credit unions, as well as life insurance, equities, bonds, retirement savings, and mutual fund accounts with matching values. Bank documents and investment account statements, in addition to cash reserves, are required to demonstrate that you have funds for the down payment and closing charges.
You must also include any obligations, such as revolving charge accounts, alimony, child support, vehicle loans, school loans, and any other existing bills.
Transactional Specifics
An outline of the major transactional information, such as the purchase price, loan amount, value of repairs and renovations, anticipated closing expenses, buyer-paid discounts, and mortgage insurance (if applicable). (Much of this information will be filled in by the lender.)
Proclamations
A list of any judgments, liens, bankruptcies, or foreclosures in the past, current litigation, or outstanding bills. The question of whether you are a citizen or lawful permanent resident of the United States and if you intend to use the property as your primary residence will also be asked of you.
What Follows Happens?
Within three business days of receiving your completed mortgage application, a lender is obligated by law to present you with a three-page document known as a loan estimate.
This documentation details the loan amount, terms and kind of mortgage, interest rate, expected interest and payments, estimated closing expenses (including any lender fees), an estimate of property taxes and homeowners insurance, and any special loan features. It also states whether the mortgage has been pre-approved (such as balloon payments or an early prepayment penalty).
In order to assist you in setting a more realistic house purchase budget, it also determines a maximum loan amount based on your financial situation.
Upon receiving pre-approval for a mortgage, your loan file will eventually be sent to a loan underwriter who will cross-check your supporting evidence with your mortgage application. Along with making sure you comply with the borrower requirements for the particular loan program you're looking for, the underwriter will also check your credit history.
Required Documentation
Following the submission of your mortgage application, you will be required to obtain a number of papers to verify your information. Your preparation and organization will make the process run more smoothly. To get pre-approved or to receive final loan approval before closing, you must produce the following documents:
- Bank statements over the last 60 days
- Pay stubs over the last 30 days
- W-2 tax returns for the last two years
- Self-employed borrowers should use Schedule K-1 (Form 1065).
- Returns on Income
- Statements of assets (retirement savings, stocks, bonds, mutual funds, etc.)
- a driver's license or a passport from the United States
- Divorce documents (to use alimony or child support as qualifying income)
- Letter of thanks (if funding your down payment with a financial gift from a relative)
Gifts for the Down Payment
A relative's financial contribution can often be applied to the down payment of several loan products. If you take it this way, a lender will require you to sign a standard gift letter in which you and the gift donor state that the gift is not a third-party loan with a payback obligation.
If not, your DTI ratio may rise as a result of the agreement, which might affect your ability to borrow money in the end. Furthermore, to source the transfer of cash amounts from one account to another, both you and the donor will be required to furnish bank statements.
Pre-approval Influencing Factors
You must be aware of the elements that lenders take into account when evaluating your financial profile if you want to increase your chances of receiving a mortgage pre-approval. They are as follows:
- The DTI ratio
- The LTV ratio
- History of credit
- FICO Score Earnings
- Work experience
The DTI Ratio
All of your monthly debts are compared to your monthly income to determine your DTI ratio. Lenders total your debts, including auto loans, school loans, revolving charge accounts, and other lines of credit, then divide the total by your gross monthly income to calculate a percentage.
To qualify for a mortgage, borrowers should keep their DTI ratio at (or below) 43% of their gross monthly income, depending on the loan type.
The greater the risk you represent to lenders, the more probable it is that you will find it difficult to repay your loan on top of other debt obligations.
A lower DTI ratio may entitle you to a reduced interest rate. Pay off as much debt as possible before purchasing a property. You will not only reduce your DTI ratio, but you will also demonstrate to lenders that you can handle debt responsibly and pay obligations on time.
The LTV Ratio
Your LTV ratio, which is computed by dividing the loan amount by the home's value, is another important measure that lenders use to evaluate you for a mortgage.
The worth of a property is determined by an appraisal, which may be lower or greater than the seller's asking price. Your down payment is factored into the LTV ratio formula.
An upfront payment made in cash to the seller at the closing table is known as a down payment. The bigger your down payment, the smaller your loan amount and hence your LTV ratio. If you put down less than 20%, you may be compelled to pay private mortgage insurance (PMI).
It is a sort of insurance that protects lenders in the event that you fail to repay your mortgage. To reduce your LTV ratio, you must either put down more money or purchase a less costly home.
Background and Score on Credit
The three major reporting agencies, Equifax, Experian, and TransUnion, are where lenders will obtain your credit reports. Your payment history, whether or not you pay bills on time, the number and kind of open credit lines, and the number of years you've had those accounts will all be factors they consider.
Lenders look at how much of your available credit you actively utilize, also known as credit utilization, in addition to your payment history. Maintaining a credit usage rate of 30% (or below) improves your credit score.
It also demonstrates to lenders a responsible, regular history of bill payment and debt management. All of these factors contribute to your FICO Score, which is a credit score model utilized by many different types of lenders (including mortgage lenders).
You can have problems receiving a mortgage pre-approval if you haven't obtained any credit cards or conventional lines of credit, such as a car loan or school loan. You may improve your credit score by acquiring a starter credit card with a low credit line limit and paying off your monthly bill on time. Your payment activity may not be reflected in your credit score for up to six months. It's critical to remain patient while you develop your credit.
A FICO Score of 620 or above is required by most lenders to grant a conventional credit, and some even need that score for a Federal Housing Administration (FHA) loan. Customers with credit scores of 760 or above often receive the lowest interest rates from lenders.
According to FHA criteria, eligible applicants with a credit score of 580 or above can put down as little as 3.5%.
Those with poorer credit ratings must put down a higher deposit. Lenders will frequently work with customers who have low or somewhat low credit scores and provide strategies for them to raise their scores.
The table below displays your monthly principal and interest (PI) payment on a 30-year fixed-rate mortgage for three standard loan amounts based on a variety of FICO Scores. (Because interest rates fluctuate often, utilize this FICO Loan Savings Calculator to double-check your scores and rates.) On a $250,000 loan, a homeowner with a FICO Score in the lowest (620-639) band would pay $1,675 per month, but a homeowner with a FICO Score in the highest (760-850) range would pay just $1,416 (a difference of $3,108 per year).
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| Pre-approval for a Mortgage: How to Do It |
Based on a range of credit scores, estimated monthly payments
| FICO Score Range | 620–639 | 640–659 | 660–679 | 680–699 | 700–759 | 760–850 |
| Interest Rate | 7.07% | 6.524% | 6.09% | 5.88% | 5.703% | 5.481% |
| $350,000 Loan | $2,345 | $2,218 | $2,120 | $2,072 | $2,032 | $1,983 |
| $250,000 Loan | $1,675 | $1,584 | $1,514 | $1,480 | $1,451 | $1,416 |
| $150,000 Loan | $1,005 | $950 | $908 | $888 | $871 | $850 |
Borrowers Who Are Self-Employed
When you are a self-employed borrower, you may be required to supply extra documentation demonstrating a regular income and employment history of at least two years.
Some papers that may be asked for are a profit and loss statement, a company license, a signed declaration from your accountant, federal tax returns, balance sheets, and bank records for past years (the exact amount of time depends on the lender).
Self-employed borrowers must often provide tax returns from the two most recent years, as well as any necessary schedules.
The stability of the borrower's income, the location and nature of the borrower's business, the demand for the product or service offered by the business, the financial strength of the business, and the ability of the business to continue generating and distributing sufficient income to enable the borrower to make the mortgage payments are all factors in approving a mortgage for a self-employed borrower.
There are two choices designed expressly for borrowers who are self-employed if your position makes it impossible for you to obtain a conventional mortgage.
1- Mortgage based on stated income or stated assets
The income you submit to the lender for this sort of mortgage is used as the basis for the loan without any official verification. Because lenders will verify the sources of your income rather than the quantity, stated income loans are also known as low-documentation loans.
Individuals who work for themselves should be ready to present a list of their most recent clients as well as any additional sources of income, such as income-generating investments. A copy of Internal Revenue Service (IRS) Form 4506 or 8821 may also be requested by the bank.
By using Form 4506, you may get a copy of your tax return straight from the IRS, preventing you from giving the lender fake results. It costs $43 per return, however, Form 4506-T may be available for free.
With the use of Form 8821, your lender is granted permission to inspect your designated forms for the years you specify for free at an IRS office.
2- Loan with No Documentation
The lender will not seek to verify any of your income details with this sort of loan, which may be a viable alternative if your tax returns reflect a company loss or a very modest profit. Because it is riskier for a bank to lend money to someone with unverified income, your mortgage interest rate will be greater for a no-documentation loan than for a full-documentation one.
Alt-A mortgages are low- and no-documentation loans with interest rates that lie between prime and subprime.
Decisions on Pre-approval
A lender will normally offer you one of three options after analyzing your mortgage application: pre-approved, refused outright, or pre-approved with conditions. In the third situation, you may be required to supply more documents or decrease your DTI ratio by paying off some credit accounts in order to meet the lender's requirements. If you are refused outright, the lender should explain why and give you options to help you deal with the issues.
Borrowers in many circumstances need to focus on improving their credit score and repairing a shaky payment history. When you know what you need to work on, you can put in the time and effort to improve your credit and financial health in order to receive a better mortgage offer when you're ready to start looking for a home.
When browsing for several lenders, you may save a significant amount of money on mortgage pricing and guarantee that you obtain reduced interest rates and conditions.
Letter of Pre-approval
Your lender will offer you a pre-approval letter on official letterhead if you are pre-approved. This formal document shows sellers that you're a serious buyer and that you have the financial capacity to follow through on an offer to buy their house. Most sellers anticipate purchasers to have a pre-approval letter and will be more prepared to haggle with those who can demonstrate financial capability.
The purchase price, loan program, interest rate, loan amount, down payment amount, expiry date, and property address are often included in pre-approval letters. The letter is included with your offer; some sellers may also ask to view your bank and asset records.
Obtaining pre-approval does not bind you to a certain lender. When you're ready to make an offer, you may select the lender with the best rate and conditions for your situation. Additionally, obtaining a pre-approval does not ensure that a lender will grant you a mortgage, particularly if your financial, job, and income situation changes between the pre-approval and underwriting phases.
Is a credit check required for mortgage pre-approval?
It's really unlikely. Some lenders may allow initial qualification without a thorough credit check; at that time, they may be concerned merely with whether you have the money to repay a mortgage and no credit red flags. However, a credit check will probably be necessary to obtain full-scale pre-approval.
It is critical to understand how long pre-qualification and pre-approval will be in force. Letters of pre-qualification or pre-approval are valid for varying periods of time, ranging from 30 to 120 days, depending on the lender.
You don't want to have credit history checks performed frequently because doing so might harm your credit rating. For the same reason, you should not apply for it until you are ready to begin really looking for a property.
To avoid going through the pre-qualification or pre-approval procedure only to find that there is nothing in your market that you can actually afford or want, many lenders and real estate agents can assist you to acquire a range of what you can afford in general.
Pre-approval for a mortgage takes how long?
The lender determines how long it takes to respond. Some lenders claim same-day approval, while others may take several days or a week. Keep in mind that the words "pre-qualified" and "pre-approved" may have varied meanings across lenders and are sometimes used interchangeably, so the time it takes to get them might vary. It's crucial to confirm if pre-qualification or deeper pre-approval is what the lender is truly doing.
What can I do to improve the amount of my mortgage pre-approval?
Ascertain that the prospective lender has proper information, particularly about your income and liabilities. You can request to examine the credit report utilized by the lender, and if you feel it includes inaccuracies, you can contact the appropriate credit bureau.
You must also contact the firm that supplied the information. You may also try other lenders, who may have different requirements. But keep in mind that conducting several credit checks quickly might harm your credit rating.
How likely is it that a pre-approval mortgage application will be rejected?
It's not likely if you've stuck to your budget, but it does happen. Remember that a pre-approval is a statement that you are generally qualified to repay a mortgage, but a mortgage approval is unique to a certain transaction.
The lender may consider you are paying too much or may have discovered obligations that were not discovered during the pre-approval process. Additionally, you might need to get mortgage insurance, which raises your payments, if you can't put down a particular amount of the buying price—typically 20%.
You are under no obligation to continue working with the lender that granted you pre-approval, so you should think about applying with another lender, which is a smart move in any case.
What is the validity period of a pre-approval for a house loan?
The duration varies depending on the lender, but it is normally between a month and 90 days—and, in some situations, six months. It's a good idea to maintain track of the expiration date so that you avoid discovering that your pre-approval has expired after finding a dream house that you can afford.
Pre-approval with many lenders is a good approach to comparing interest rates and locating the best price. Again, you'll want to shop mortgage lenders within 45 days so that all credit checks count as one single inquiry and your credit score suffers the least harm. If you're just starting to consider homeownership, the pre-approval procedure can help you get your credit and finances in order for when the time comes.
Keep in mind that a mortgage pre-approval does not guarantee you a loan. Before your loan closes, pre-approval letters are conditional on your financial and job information being accurate and consistent.
Similarly, if you neglect to disclose critical information—a divorce, an IRS tax lien, or another issue—and a loan underwriter discovers it later, your loan may be denied.
