Do you know the first step you should take when you’re ready to buy a house? You might be surprised to learn that it isn’t browsing real estate sites or even making a list of things you’re looking for in a home. While both are important (and likely a bit more fun than what we’re about to suggest), these steps should only come after you’ve secured pre-approval from a lender.
Today’s competitive markets make having an edge over other buyers essential. If you enter a bidding war on property with multiple offers and you don’t have a pre-approval letter, your offer will likely be shuffled to the bottom of the pile. Pre-approval letters signify to sellers that you’re serious and that you’re less likely to walk away from your offer due to financing issues.
What is mortgage pre-approval?
Mortgage pre-approval means that a lender has conditionally approved you for a mortgage loan. When you receive your pre-approval letter, you’ll know exactly how much a lender is willing to let you borrow. Having a mortgage pre-approval letter makes your house hunt easier because you won’t spend time falling in love with homes you can’t afford.
It’s important to note that a pre-approval letter is not a commitment from the lender. It is simply an offer. Final approval of your loan application is subject to underwriting, which is the process by which an underwriter reviews both your finances and the property in question to assess the level of risk a lender would take on in issuing you a mortgage.
Mortgage pre-approval requires an investigation into your personal finances. When you apply for pre-approval, you’ll need to provide evidence of your employment, income, debts, and assets.
Some of the documents you should have on hand include:
- Tax returns from the last two years
- Pay stubs from the last six months
- Other income statements (self employment etc.)
- Gift letters (if anyone is providing funds towards your down payment)
- Bank statements
- Employer information
- Personal identification information
- Investment account information
When deciding how much of a loan to pre-approve you for, a lender will looking at the following:
- Credit history and credit score
- Employment history
- Debt-to-income ratio
- Assets and liabilities
Pre-approvals are a particular way for a lender to determine whether you’re a likely candidate for a mortgage loan.
Pre-approval vs. Pre-qualification
During your research, you may have seen the terms “pre-qualification” and “pre-approval.” While they are similar, they aren’t the same thing. Pre-qualification can give you a basic idea of how much home you can afford. Still, it’s not as intensive as a pre-approval, and it carries no weight during the buying process.
To pursue a pre-qualification, you’ll need to submit your social security number and employment information to a lender, usually via their website. During the pre-qualification process, a lender will run a soft credit check to verify your financial information. A soft credit check allows the lender to get an overview of your credit history, but it doesn’t provide as much information as a hard credit pull. A soft credit check also doesn’t affect your credit score. A pre-qualification may make sense if you’re early in the house buying process and just want a basic idea of how much money a lender might be willing to let you borrow. There are no long-term consequences to a pre-qualification, so it’s a good first step if you’re unsure of whether now is the right time to buy.
For pre-approval, lenders will run your credit score and do a complete review of your financial history. A pre-approval requires more information, including your social security number, income information, bank statements, and investment information. During pre-approval, the lender will run a hard credit check. A hard credit check affects your credit score. It also gives your lender a more complete picture of your financial situation before making an offer of lending, which you will get in the form of a pre-approval letter.
A pre-approval letter gives you an indication of your purchasing power and will generally contain the following:
- Property Address (if known)
- Anticipated Sales Price
- Loan-to-value (LTV) Ratio
- Down Payment
- Loan Type
- Interest Rate
- Loan Amount
- Loan Term
Most pre-approval letters are good for 90 days, during which time you can choose to apply for a loan at the rate and terms quoted.
If you’re serious about buying a home, a pre-approval letter will help you stand out when making an offer. This shows a seller that you are financially prepared to take on a mortgage and are not likely to have any hold ups when it comes to getting final approval from your lender. As a result, a seller is more likely to take your offer seriously compared to someone who comes in with just a pre-qualification.
Benefits of Getting a Mortgage Pre-approval
Filling out paperwork and gathering financial documents sounds like a lot less fun than touring homes, imagining paint colors, and planning your furniture layout. However, how you handle the financing of your home is arguably more important than any other step in the buying process. Since you’ll likely be in your home for many years, the choice you make now will affect you for a long time.
Pre-approval provides numerous benefits, including:
A fixed budget before going house shopping
You can narrow down your house hunt because the pre-approval letter includes the maximum amount you qualify for. To save as much money as possible, aim for a home under the full amount, so you have wiggle room in your monthly budget.
Better odds of your offer being accepted
If a home gets multiple offers, having a pre-approval letter could give you an edge. One of the most common causes of delays in the sales process is financing. A pre-approval shows the seller that you’re serious and ready to make a purchase.
You’ll save time when you find the right house
Since your lender has already investigated your finances thoroughly, finalizing your paperwork should take less time. The lender will likely already have most of the information they need, though they may request a few additional documents.
Tips for Getting Pre-approval
Since the pre-approval process involves hard inquiries on your credit report, you’ll want to make sure you’re ready to qualify. Some things you can do to improve your chances of approval include:
Check your credit report
You can access a free credit report from each major credit reporting company once per year. Check your statements to look for late payments, errors, or other issues you may not be aware of. Make sure to contact each credit reporting agency to correct any errors. Even with some delinquencies, you may still qualify for pre-approval. Still, seeing everything listed can give you a better idea of if you’re ready to apply or need to make some improvements to your credit score.
Check your credit score
The most common way to find out your credit score is to purchase it from one of the three main credit reporting bureaus. However, some major credit card companies may provide your credit score for free. Ideally, your credit score should be close to 640 to secure average mortgage rates, though FHA loans may accept scores as low as 550. There are several ways that you can improve your credit score before applying for a mortgage.
Have a down payment ready
If your credit score is less than ideal, a higher down payment could make it easier to qualify for a loan. A down payment of 20% or more will also prevent you from having to pay private mortgage insurance (PMI), which can add an additional 0.5-1% to your loan each year.
Stick to deadlines
Meeting deadlines is essential during the home buying process. If you fail to turn in documents on time, you could lose your loan or the home you’re offering to purchase. Keep all critical financial information handy, so you can access it quickly if necessary.
Avoid spending on your credit cards
Try not to make any purchases on your credit cards in the weeks or months up to the time you plan to apply. You should focus on reducing your balances instead. Lower debt-to-income ratios mean a higher credit score and better odds of approval.
Do you have a foreclosure or bankruptcy on your credit?
Most lenders will not approve mortgage loans for borrowers with foreclosure or bankruptcy proceedings in the last three to seven years. The longer the time that goes by since the bankruptcy or foreclosure, the less impact it has on your credit.
Apply for pre-approval only when you’re ready to start shopping
Apply for a pre-approval letter right before you’re ready to start shopping for a home. The letter will help you figure out your budget. Most pre-approval letters are good for 90 days, so you could run out of time if you apply too early and the housing market is very competitive.
Seek approval letters from multiple lenders
Ideally, you should obtain pre-approval from at least two or three lenders. If you seek pre-approval for loans from multiple companies within a month, the credit reporting companies will lump them all together, so it won’t impact your credit score as much. Multiple letters mean you have choices when it comes time to get final approval. Shopping around allows you to find the best rates and terms.
Warning: Ways You Can Lose Pre-approval
Even if you receive a pre-approval letter, you should know that you can lose the loan if you make a few common mistakes. Some things you’ll want to avoid are:
- Spending too much on your credit cards
- Taking out a new loan
- Changing jobs
- Making late payments on accounts
- The lender finding income with no source
One other reason a lender might deny your loan is if the appraisal on the home you’re purchasing comes back under what you offered. Lenders will not fund a loan for more than a property’s value. You can offset this risk by bringing a larger down payment or ensuring that your offer is below the property’s market value.
You can avoid many of these problems by keeping your credit cards locked away, paying your bills on time, and obtaining gift letters for any money received from friends or family.
Ready to take the next step?
REX Home Loans offers a quick pre-approval process to help jump-start your home search. By removing the high cost of commissions for our loan advisors, we offer competitive rates from some of the industry’s top lenders. Because our mortgage advisors don’t work on commission, there is never any pressure to go with one lender over another. Our goal is to help you find the best option for your mortgage, while bringing greater ease and transparency to the borrowing process.
If you’re curious about your financing options, get in touch with REX. With brokerage, mortgage, title and escrow, insurance, and home services all under one roof, we’ll be with you every step of the way toward finding, financing, and closing on your next home.