The first step in the home buying process is to get pre-approved for a mortgage.
Pre-approved is different than just pre-qualified.
In this article we’ll break down the mortgage pre-approval process.
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What Does it Mean to be Pre-Approved
Being pre-approved for a mortgage means that a mortgage lender has checked your credit, employment, and income and you qualify for a loan up to a certain amount.
The lender at this point has enough information about the borrower to determine whether they meet their loan guidelines or not.
For a mortgage pre-approval the borrower must complete a loan application, have their credit and score checked,verify income using W2’s and tax returns.
The funds for the down payment will also need to be verified with a bank statement.
Your debt-to-income ratio is then calculated to ensure you meet the lenders guidelines.
Your total monthly debt payment payments are added together and divided by your gross monthly income.
Based on your DTI ratio the lender will be able to calculate the maximum loan amount you are approved for.
You’ll receive a mortgage pre-approval letter that shows how much you are approved for.
Pre-Qualified vs. Pre-Approved
Some terms even sound very familiar when in fact they’re very different and two of these terms are “pre-qualified” and “pre-approved”.
The primary difference is the degree of validation.
Let’s take a closer look at the two and why getting pre-approved is important as you begin your home shopping journey.
What is a Mortgage Pre-Qualification?
Ever get a pre-qualified credit card offer in the mail?
It doesn’t mean you’re pre-approved for the card but the creditor thinks you are a good candidate for a certain card based on limited information given to them from the credit bureaus.
This is the same thing when it comes to a mortgage.
A mortgage pre-qualification is just a lender thinking you could qualify for one of their mortgage products based on very little information.
So in the real estate industry being pre-qualified for a mortgage loan doesn’t really mean anything.
What is a Mortgage Pre-Approval?
While you can get pre-qualified without even doing anything.
Getting pre-approved is much more in-depth requiring income documents and a credit check.
A mortgage loan pre-approval lets everyone involved know that you’re serious about buying a home.
That includes your agent, the sellers and the seller’s agent. Typically a lender will have you complete a mortgage application to start the process.
The Mortgage Pre-Approval Process
You will need to complete a loan application and provide the necessary documentation to verify your income. Here is what you can expect to provide:
- Last few pay stubs
- Past 2 years of W’2
- Past 2 years of Tax returns
- 2-3 months of bank statements where downpayment is coming from
- The lender will need to check credit
A mortgage pre-approval letter provides the necessary third-party verification that what you told your loan officer is documented.
You’ll be asked to provide your most recent pay check stubs covering a 30 day period as well as your two most recent W2 forms.
Lenders will ask that you have at least two years of employment and your two W2 forms will document this requirement.
Your pay check stubs will also show a year-to-date amount which should coincide with your regular pay.
Part time income
Part time income can be used as well as long as you can show there is at least a two year history of part time employment and the lender can make a reasonable determination the part time income will continue into the future.
A common situation where part time income is used is in the case of a substitute teacher, for example.
If you’re self-employed or get additional income outside of your job and you want to use that other income to help get your pre-approval.
You’ll provide your two most recent federal income tax returns both personal and business.
In addition, you can expect to provide a profit and loss statement for the current year.
Most often this P&L can be compiled by you but sometimes a lender will request the P&L be completed and certified by a CPA.
When lenders look at your returns they want to see consistency from year to year. They will average your annual net income to arrive at a median yearly income that will be used.
For example, year one you made $90,000 and year two $95,000. The qualifying amount will be $90,000 + $95,000= $185,000 divided by 2= $92,500 average yearly income.
Credit score needed for pre-approval
The scores will range from 350 to 850. Typically, a borrower must have a 620 credit score to qualify for a mortgage loan.
Your credit score is one of the main things lenders are looking for when pre-approving a borrower.
Not only do you need to meet the minimum credit requirements, you cannot have too many late payments, collection accounts, or excessive debt.
Credit Score Ranges
- 720+ = Excellent Credit
- 680-719 = Good Credit
- 620-679 = Fair Credit
- 580-619 = Poor Credit
- 579 or under = Bad Credit
Cash to Close
Your lender will also need to verify sufficient funds to close on a purchase.
This includes not simply enough for a down payment but for the associated closing costs as well.
Lenders also want to see some funds available after you close which lenders refer to as “cash reserves.”
The reserve amount can vary based upon the type of loan being applied for or a particular lender’s own internal guidelines.
Being pre-approved for a mortgage is necessary
In today’s marketplace, sellers expect to see a pre-approval letter.
That’s much different than it was a few years ago when getting approved for a mortgage was much easier.
A pre-approval letter is your own peace of mind. You can now shop with confidence.
Do you think you’re ready to get pre-approved?
Mortgage Pre-Approval FAQ
Does a mortgage pre-approval hurt your credit score?
When getting pre-approved a lender will pull a copy of your credit report and scores. This is called a hard inquiry. Credit inquiries do impact your credit score but not substantially.
Credit inquiries and other new credit accounts make up just 10% of your overall FICO score. A single inquiry may lower your score a little but usually only a large number of inquiries will drop your score.
How long does it take to get pre-approved for a mortgage?
Getting pre-approved for a loan can happen quite quickly, usually the same day. If you have your documents ready to go, the lender can check your credit and run the numbers in a few minutes.
Does it cost money to get pre-approved?
Generally, most lenders will not charge a fee to get a borrower pre-approved. Some smaller lenders and mortgage brokers may charge a small fee for the credit report.
What’s the difference between pre-approved and pre-qualified?
Pre-qualified means you may qualify based on a small glimpse of your credit report. Pre-approved means that a lender has checked your credit and verified your income.