Buying a home can feel like a cutthroat process.
But getting mortgage preapproval can help you, especially in a hot house market.
What Is Mortgage Preapproval?
Mortgage preapproval comes in the form of a letter from a lender that states that you qualify for a loan of a certain amount and at a certain interest rate based on an evaluation of your credit and financial history.
The letter is an offer, but not a commitment, to lend you a specific amount. It’s good for up to 90 days, depending on the lender.
You’ll want to shop for homes within the price range of your preapproved mortgage.
Armed with a letter of preapproval, you can show sellers that you are a serious homebuyer with the means to purchase a home. In the eyes of the seller, preapproval can often push you ahead of other potential buyers who have not yet been approved for a mortgage.
Once you find a house that you want to buy, you can make an offer. And if the seller accepts, it’s time to finalize your mortgage application.
A loan underwriter will review your application and conduct other due diligence measures, such as having the house appraised to make sure it is valued at the price it’s selling for.
If all goes well, the lender will issue a commitment letter, which officially seals the deal on your loan, and you can schedule a closing date.
Preapproval vs. Prequalification
As you begin to look into getting a mortgage, you may encounter another term: prequalification.
Getting prequalified for a mortgage is not the same as being preapproved. It’s actually a relatively simple process in which a lender looks at a few financial details, usually self-reported, such as income, assets, and debt, and estimates how much of a mortgage the lender thinks you can afford.
Prequalification gives you an idea of what your monthly payment might be and provides a chance to shop around with various lenders to see what types of terms and interest rates they offer. (Prequalification is not a guarantee that you will actually qualify for a mortgage.)
Taking out a mortgage is a huge step, of course. Prequalification can be useful, because it gives you an idea of how much house you can afford.
This home affordability calculator can also help in estimating how much you can afford.
Getting preapproved is a more complicated process. You’ll have to fill out an application with your chosen lender, agree to a credit check, and provide information about your income and assets.
Upping Your Odds of Preapproval
There are a number of steps you can take to increase your chances of preapproval or to increase the amount your lender may approve.
Build Your Credit
When you apply for any type of loan, lenders want to see that you have a history of properly managing your debt before offering you credit themselves.
You can build your credit history by opening and using a credit card and paying your bills on time. Or you could consider having regular payments, such as your rent, tracked and added to your credit score.
Check Your Credit
If you’ve established a credit history, a first step before applying for a mortgage is to check your credit reports, which are a history of your credit compiled from sources like banks, credit card companies, collection agencies, and the government.
The information is collected by the three main credit reporting bureaus, Transunion, Equifax, and Experian. You’ll want to make sure that the information on your credit reports is correct. Ordering the reports is free .
If you find any mistakes, contact the credit reporting agencies immediately to let them know. You don’t want any incorrect information weighing down your credit score, putting your chances for preapproval at risk.
The free credit reports provided by the nationwide credit reporting agencies do not include your credit score, a number typically between 300 and 850. You can purchase your score directly from the credit reporting agencies, or from FICO®. Your credit card company may provide your credit score for free.
Or you could try an app that updates your credit score weekly and tracks your spending at no cost.
Stay on Top of Debt
Your ability to pay your bills on time has a big impact on your credit score. And if your budget allows, you can make payments in full.
If you have any debts that are dragging down your credit score—for example, debts that are in collection—it’s smart to work on paying them off first, as this can give your score a more immediate boost.
Watch Your Debt-to-Income Ratio
Your debt-to-income ratio is your monthly debt payments divided by your monthly gross income. If you have $1,000 a month in debt payments and make $5,000 a month, your debt-to-income (DTI) ratio is $1,000 divided by $5,000, or 20%.
Mortgage lenders typically like to see a DTI ratio of 36% or less.
Lenders may assume that borrowers with a high DTI ratio will have a harder time making their mortgage payments. If you’re seeking preapproval for a mortgage, it may be beneficial to keep the ratio in check by avoiding large purchases. For example, you may want to hold off on buying a new car until you’ve been preapproved.
Prove Consistent Income
Your lender will want to know that you have enough money coming in each month to cover a potential mortgage payment, so the lender will likely want proof of consistent income for at least two years (that means pay stubs, W-2s, etc.).
For some potential borrowers, such as freelancers, this may be a tricky process since they may have income from various sources. Keep all pay stubs, tax returns, and other proof of income and be prepared to show them to your lender.
What Happens If You’re Rejected?
Rejection hurts. But if you aren’t preapproved, or you aren’t approved for a large enough mortgage to buy the house you want, you also aren’t powerless. You can ask the lender why it said “no.” This will give you an idea about what you might need to work on in order to secure the mortgage you want.
Then you may want to work on the factors that your lender saw as a sticking point to preapproval. You can continue to work to boost your credit score, lower your DTI ratio, or save for a higher down payment.
If you’re able to pay more upfront, you will typically lower your monthly mortgage payments. Once you’ve worked to make yourself a better candidate for a mortgage, you can apply for preapproval again.
In a competitive market, having a mortgage preapproval letter in hand may give a house hunter an edge. After all, the letter states that the would-be buyer qualifies for a home loan of a certain amount.
If you’re shopping for a mortgage, give SoFi a look. SoFi home loans come with competitive rates and as little as 5% down.It takes just two minutes to check your rate.
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