August 17th, 2020 9:29 AM by Jackie A. Graves, President
If you're house hunting, it's important to know the difference between mortgage prequalification and preapproval.
Mortgage prequalification lets a lender tell you how much money you could qualify to receive. When a lender preapproves your credit, they make a conditional agreement to offer you a set mortgage amount. A preapproval, on the other hand, can save you a lot of time and heartache during the mortgage process. In the event of multiple offers on a home, buyers with preapproval are more likely to win over a buyer who has no financial backing.
If you’re ready to commit to the homebuying process, then you should follow these steps before submitting a loan application.
How to get pre-approved for a mortgage in 5 steps
Getting preapproved for a mortgage loan isn’t difficult if you do a little preparation beforehand. Follow these steps to ready yourself for the preapproval process:
1. Know your credit score
Before submitting any paperwork or touring homes, get a copy of your credit score — as credit checks during the mortgage application process are inevitable. There are several ways to access your credit history, including paying one of the three major credit bureaus for access. Alternatively, major credit card companies like American Express, Discover, and Capital One offer a free credit score updated once per month.
The credit score you need will depend on the type of loan you’re looking to obtain.
A good credit score can help you qualify for lower interest rates. If your credit is in good shape, then check out ChangeMyRate.com to determine what kind of mortgage rates you'd qualify for today.
2. Understand your debt-to-income ratio
Although other factors affect your credit score, one of the most important things that will determine how much, if any, money a lender is willing to give you is your debt-to-income ratio (DTI). You can calculate your debt-to-income ratio by dividing your debt payments by your gross income.
Debts your credit score considers include:
You may have other obligations that don’t show up on your credit report like:
Lenders may not look at debt payments that don’t appear on your credit report; however, you should consider adding them to your equation to determine if you feel comfortable taking on additional debt.
For example, let’s look at a potential borrower with a $5,000 per month income after taxes. They have the following debts:
This borrower has a DTI of 30 percent. That means 30 percent of their income goes towards debt payments. When looking at approving a loan, lenders also factor in the potential mortgage payment for the DTI ratio. So, if this borrower had a mortgage payment of $1,200 per month, their DTI would increase to 54 percent.
The Consumer Financial Protection Bureau notes that most lenders only allow a maximum of a 43 percent DTI, though lenders prefer to see a number closer to 30 percent or lower. You can estimate how much a mortgage loan will affect your DTI by using an online savings calculator.
3. Gather documents for preapproval process
Once you’ve reviewed your credit score and debt-to-income ratio, begin putting your paperwork together. Set up a digital folder on your computer or keep a paper folder in a safe place. You’ll want to have the following documents on hand:
When you use an online mortgage broker like ChangeMyRate.com, you can get personalized rates and pre-approval letters without a hard inquiry that could negatively affect your credit score.
4. Research your lending options from multiple mortgage lenders
Now it’s time to research different lender options. Check out the interest rates and APRs. When you’re researching these, remember:
Ask your lenders about fees they charge with your loan. Typical fees lenders charge for mortgage loans include origination fees, closing costs, title fees, PMI, taxes, and other miscellaneous charges. Your loan origination fee will likely be the most expensive. Most origination fees are about 1 percent of the loan ($2,000 on a $200,000 loan).
You can apply with multiple lenders at once if you want to get a more accurate interest rate. If you apply to multiple lenders within a few weeks, they are lumped together for minimum impact on your credit score. Use an online comparison website like ChangeMyRate.com to get rates from several lenders at once.
Do not be afraid to ask questions. Questions you will want to consider include:
5. Take charge of your finances to avoid setbacks
Once you are ready to apply for a home loan, put your credit cards away and don’t use them again until you have the keys to your new home in hand. Buyers can (and have) lost a preapproval buying furniture for their new home on credit.
You’ll also want to avoid switching jobs, opening new lines of credit, making late payments, or changing bank accounts. Try to keep your financial transactions as simple as possible, so your lender doesn’t have a reason to back out of the preapproval.
Most homebuyers can prequalify for a loan in a few minutes or hours. If you want preapproval, expect it to take at least a few days. If your credit is less than perfect, it can take even longer. You can find out if you qualify for a quick preapproval letter in less than three minutes by using ChangeMyRate.com to compare rates from multiple lenders.
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