November 27th, 2019 8:47 AM by Jackie A. Graves, President
As you search for a home getting pre-approved for a mortgage is an
important step to take. This step helps to clarify our house-hunting budget or
the monthly mortgage payment you can handle. Before lenders decide to
pre-approve you for a mortgage, they will look at several key factors:
Think of a mortgage pre-approval as a physical exam of your
finances. Expect lenders to poke and prod into all corners of your financial
life to ensure you’ll repay your mortgage. As a borrower, it’s important to
know what a mortgage pre-approval does (and doesn’t do), and how to boost your
chances of getting one.
You’ve likely heard the term “pre-qualification” used
interchangeably with pre-approval, but they are not the same. With a
pre-qualification, you provide an overview of your finances, income, and debts
to a mortgage lender who then gives
you an estimated loan amount. However, the lender
doesn’t pull your credit reports or verify your financial information.
Accordingly, pre-qualification is a helpful starting point to determine what
you can afford but carries no weight when you make offers.
On the other hand, a pre-approval involves filling out a
mortgage application and providing your Social Security number so that a lender
can do a hard credit check. A hard credit check is triggered when you apply for
a mortgage, and a lender pulls your credit report and credit score to assess your
creditworthiness before deciding to lend you money. These checks are recorded
on your credit report and can impact your credit score. On the other hand, a
soft credit check is when you pull your credit yourself, or when a credit card
company or lender pre-approves you for an offer without you asking.
Also, you’ll list all of your bank account information,
assets, debts, income and employment
history, past addresses, and other critical details for a lender to verify.
Why? Above all, a lender wants to ensure you can repay your loan. Lenders also
use the provided information to calculate your debt-to-income and loan-to-value
ratios, which are essential factors in determining the interest rate and ideal
Mortgage pre-approval letters are typically valid for 60 to 90
days. Lenders put an expiration date on these letters because your finances and
credit profile could change. When a pre-approval expires, you’ll have to fill
out a new mortgage application and submit updated paperwork to get another one.
If you’re just starting to think about buying a home and suspect
you might have some difficulty getting a mortgage, going through the
pre-approval process can help you identify credit issues — and give you time to
address them. Seeking pre-approval six months to one year in advance of a
serious home search puts you in a stronger position to improve your overall
credit profile. You’ll also have more time to save money for a down payment and closing costs.
When you are ready to write offers, a seller often wants to see
a mortgage pre-approval and, in some cases, proof of funds to show that you’re
a serious buyer. In many hot housing markets, sellers have an advantage because
of intense buyer demand and limited homes for sale; they’re unlikely to
consider offers without pre-approval letters.
Applying for a mortgage can be exciting, nerve-wracking and
confusing. Some online lenders can pre-approve you within hours, while other
lenders could take several days. The timeline depends on the lender and the
complexity of your finances.
For starters, you’ll fill out a mortgage application. You’ll
include your identifying information, as well as your Social Security number to
pull your credit. Mortgage credit checks count as a hard inquiry on your credit
reports, which may impact your credit score, but if you’re shopping multiple
lenders in a short timeframe (usually 45 days for newer FICO scoring models)
the combined credit checks count as a single inquiry.
Here’s a sample of a uniform mortgage application. If you’re
applying with a spouse or other co-borrower whose income you need to
qualify for the mortgage, both applicants will need to list financial and
employment information. There are eight main sections of a mortgage
The specific loan product for which you’re applying; the
loan amount; terms, such as length of time to repay the loan
(amortization); and the interest rate.
The address; legal description of the property; year
built; whether the loan is for purchase, refinance, or new
construction; and the intended type of residency (primary, secondary or
Your identifying information, including full name, date of
birth, Social Security number, years of school attended, marital status, number
of dependents and address history.
The name and contact information of current and previous
employers (if you’ve been at your current position less than two years), dates
of employment, title and monthly income.
A listing of your base monthly income, as well as overtime,
bonuses, commissions, net rental income (if applicable), dividends/interest,
and other types of monthly income such as child support or alimony. Also,
you’ll need an accounting of your monthly combined housing expenses, including
rent or mortgage payments, homeowners and mortgage insurance, property taxes,
and homeowner’s association dues.
A list of all bank and credit union checking and savings
accounts with current balance amounts, as well as life insurance, stocks,
bonds, retirement savings, and mutual funds accounts and corresponding values.
You’ll also need to list all liabilities, which include revolving charge
accounts, alimony, child support, auto loans, student loans, and any other
An overview of the key transaction details, including purchase
price, loan amount, the value of improvements/repairs, estimated closing costs,
buyer-paid discounts, and mortgage insurance (if applicable). (Note: The lender
will fill in much of this information.)
An inventory of any judgments, liens, past bankruptcies or
foreclosures, pending lawsuits or delinquent debts. You’ll also be asked to
state whether you’re a U.S. citizen or permanent resident and whether you
intend to use the home as your primary residence.
A lender is required by law to provide you with a three-page document
called a loan estimate within three business days of receiving your completed
mortgage application. This paperwork notes whether the mortgage has been
pre-approved and outlines the loan amount, terms and type, interest rate,
estimated interest and payments, estimated closing costs (including any lender
fees), an estimate of property taxes and homeowner’s insurance, and any special
loan features, such as balloon payments or an early prepayment penalty, for
example. It also specifies a maximum loan amount, based on your financial
picture, to help you narrow down your home-buying budget.
If you’re pre-approved for a mortgage, your loan file will
eventually transfer to a loan underwriter who will verify your documentation
against your mortgage application. The underwriter will also ensure you meet
the borrower guidelines for the specific loan program for which you’re
After submitting your mortgage application, you’ll need to
gather a number of documents to verify your information. Preparation and
organization on your end will help the process go more smoothly. Here’s a list
of documents you need to present in order to be pre-approved or to secure final
loan approval before closing:
If you want to maximize your chances of getting a mortgage
pre-approval, you need to know which factors lenders evaluate in your financial
profile. They include your:
Your DTI ratio measures all of your monthly debts relative to
your monthly income. Lenders add up debts such as auto loans, student loans,
revolving charge accounts and other lines of credit, plus the new mortgage
payment, and then divide the sum by your gross monthly income to get a
percentage. Depending on the loan type, borrowers should maintain a DTI ratio
at or below 43% of their gross monthly income to qualify for a mortgage.
The higher your DTI ratio, the more risk you pose to lenders because you could
be more likely to struggle to repay your loan on top of debt payments. Having a
lower DTI ratio can qualify you for a more competitive interest rate. Before
you buy a home, pay down as much debt as possible. Not only will you lower your
DTI ratio, but you’ll also show lenders that you can manage debt responsibly
and pay bills on time.
Other key metric lenders use to evaluate you for a mortgage is
your loan-to-value ratio, which is calculated by dividing the loan amount by
the home’s value. A property appraisal determines the property’s value, which
might be lower or higher than the seller’s asking price. The LTV ratio formula
is where your down payment comes into play. A down payment is an upfront sum of
money you pay, in cash, to the seller at the closing table. The higher your
down payment, the lower your loan amount and, as a result, the lower your LTV
ratio. If you put down less than 20% percent, you might be required to pay
for private mortgage
insurance (PMI). It’s a type of insurance coverage that protects
lenders in the event you fail to repay your mortgage. To lower your LTV ratio,
you either need to put more money down or buy a less expensive house.
Lenders will pull your credit reports from the three main
reporting bureaus – Equifax, Experian, and Transunion. They’ll look for your payment
history and whether or not you pay bills on time, how many and what type of
credit lines you have open, and the length of time you’ve had those accounts.
In addition to positive payment history, lenders analyze how much of your
available credit you actively use, also known as credit utilization.
Maintaining a credit utilization rate at or below 30% helps boost your
credit score, and it shows lenders a responsible, consistent pattern of paying
your bills and managing debt wisely. All of these items account for your FICO
score, a credit score model used by many types of lenders (including mortgage
If you have not opened credit cards or any traditional lines of
credit such as an auto or student loan, you might have trouble getting a
mortgage pre-approval. You can build your credit by opening a starter credit
card with a low credit line limit and paying off your bill each month. It could
take up to six months for your payment activity to be reflected in your credit
score so be patient as you build your credit profile.
When you apply for a mortgage, lenders go to great lengths to
ensure you earn a solid income and have stable employment. That’s why lenders
request two years’ worth of W-2s and contact information for your employer.
Essentially, lenders want to ensure that you can handle the added financial
burden of a new mortgage. You’ll also be asked to provide salary information,
so a lender has evidence that you earn enough money to afford a mortgage
payment and related monthly housing expenses. You’ll also have to provide 60
days (possibly more, if you’re self-employed) of bank statements to show you
have enough cash in hand for a down payment and closing costs.
If you’re a self-employed borrower, you might be asked to
provide additional documents to show a consistent income and work history of at
least two years. Some documents requested may include a profit/loss statement,
a business license, your accountant’s signed statement, federal tax returns,
balance sheets and bank statements for previous years (the exact amount of time
depends on the lender).
If your situation makes it difficult to get a traditional
mortgage, there are two options geared specifically for self-employed
This type of mortgage is based on the income you report to the
lender without formal verification. Stated income loans are sometimes also
called low-documentation loans because lenders will verify the sources of your
income rather than the actual amount. Be prepared to provide a list of your
recent clients and any other sources of cash flow, such as income-producing
investments. The bank may also want you to submit an IRS Form 4506 or 8821. Form
4506 is used to request a copy of your tax return directly from the IRS, preventing you from submitting
falsified returns to the lender, and costs $50 per return. But you may be able
to request Form 4506-T for free. Form 8821 authorizes your lender to go to an
IRS office and examine the forms you designate for the years you specify, free
In this type of loan, the lender will not seek to verify any of
your income information, which may be a good option if your tax returns show a
business loss or a very low profit. Because it is riskier for the bank to lend
money to someone with an unverified income, expect your mortgage interest rate
to be higher with either of these types of loans than with a full-documentation
loan. Low and no documentation loans are called Alt-A mortgages, and they fall
between prime and subprime loans in terms of interest rates.
Many loan products allow borrowers to use a financial gift from
a relative toward the down payment. If you go this route, a lender will ask you
to complete a standard gift letter in which you and the gift donor aver that
the gift isn’t a third-party loan with an expectation of repayment. Otherwise,
such an arrangement could increase your debt-to-income ratio, impacting your
final loan approval. Additionally, both you and the donor will have to provide
bank statements to source the transfer of cash funds from one account to another.
Your lender will provide you with a pre-approval letter on
official letterhead. This official document indicates to sellers that you’re a
serious buyer and verifies that you have the financial means to make good on an
offer to purchase their home. Pre-approval letters typically include the
purchase price, loan program, interest rate, loan amount, down payment amount,
expiration date, and the property address. The letter is submitted with your
offer; some sellers might also request to see your bank and asset statements.
Getting a pre-approval doesn’t oblige you to borrow from a
specific lender. When you’re ready to make an offer, you can choose the lender
that offers you the best rate and terms for your needs. Nor does getting
a pre-approval guarantee that a lender will approve you for a mortgage,
especially if the financial, employment, and income status changes during
the time between pre-approval and underwriting.
After reviewing your mortgage application, a lender will usually
give you one of three decisions: pre-approved, denied outright, or pre-approved
with conditions. In the third scenario, you might need to provide extra
documentation or lower your DTI ratio by paying down some credit accounts to
satisfy the lender’s conditions. If you are denied outright, the lender should
explain exactly why and provide you with resources on how to best tackle the
In many cases, borrowers need to work on boosting their credit
score and ironing out a spotty payment history. Once you know what you need to
address, you can take the time and effort to improve your credit and financial
health to get a better mortgage deal when you’re ready to embark on your home
search. Doing so can save you significant money on mortgage pricing and ensure
you get lower interest rates and terms when shopping for different lenders.
Go through the pre-approval process with several lenders to shop
interest rates and find the best deal. Again, you’ll want to shop mortgage
lenders within 45 days, so all credit checks count as one hard inquiry, with
minimum impact on your credit score. And if you’re just starting to think about
homeownership, the pre-approval process can help you get your credit and
finances in better shape for when the time is right.
Remember that a mortgage pre-approval doesn’t necessarily
guarantee you a loan. Pre-approval letters are conditional on your financial
and employment information being truthful and consistent before your loan
closes. Likewise, if you fail to disclose key information – a divorce, an IRS
tax lien or some other
issue – and a loan underwriter finds out about it later, you can receive a
denial for your loan.
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