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Mortgage preapproval: Everything you need to know to get preapproved

Getting that letter is one of the first and most important steps in the home-buying process.

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Your home-buying journey starts with getting a loan preapproval letter. 

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Buying a home -- especially for the first time -- is a complicated process. One of the first and most significant steps of buying a home is getting your mortgage preapproval. It's proof that you've lined up the financing you need to close on the home. Without a preapproval letter, most sellers aren't going to take your offer seriously.

Although some lenders have tightened their standards due to the pandemic, it's usually not too difficult or complicated to get a home-loan preapproval. Let's look at how it works.

What does it mean to be preapproved for a mortgage? 

A mortgage preapproval is a letter from a lender indicating that you are tentatively approved for a loan. It typically includes a maximum loan amount, interest rate and any other relevant terms or information. 

Significantly, getting preapproved for a mortgage doesn't guarantee you will actually get a loan -- or the specific rate and terms on offer. Rather, it's a statement from the lender stating its intention to lend and the terms involved, assuming the information you've provided about your income, employment and financial situation is accurate. It also assumes that there will be no significant changes to your financial situation or credit score -- losing your job or taking out another loan, for instance -- as these could impact the terms or even disqualify you.

"Many housing markets across the country are struggling with inventory, increasing demand substantially," said Jefferson Watters, a loan originator for AmeriSave Mortgage Corporation. "A preapproval demonstrates a commitment from the buyer and tells sellers that the buyer is completely qualified to purchase their home. In most cases, if a seller has two equal offers on the table, with the only difference being that one buyer is preapproved, the seller will almost always choose the preapproved offer."

Preapproval vs. prequalification: What's the difference?

When you start looking for a mortgage, another term you might come across is "prequalification." Though home loan preapproval and prequalification are often used interchangeably, the process and terminology varies among lenders. 

In some cases, prequalification is based on your answers to a few initial questions and a soft credit check (where a lender checks your score but doesn't pull a full report that could impact your credit). It usually doesn't include details about loan amount, interest rate or terms. As such, it's less authoritative than a preapproval -- but it's a good way to get an initial idea of whether you're in good enough financial shape to qualify for a mortgage.

"A true preapproval will verify assets, income and the ability to repay the loan," Watters said. "Some lenders will offer a preliminary prequalification letter, but this only shows a borrower qualifying based off of the information they submitted in their application."

When you're ready to make an offer on a home, you'll want to have an official statement from a lender -- or, better yet, multiple lenders -- that you can get the financing and terms you need to close on the deal. Whichever term your lender uses, make sure you have it before you make an offer.

When should you get preapproved?

When you apply for preapproval, your lender will first gather some basic financial information from you and pull your credit report. In most cases, that means a hard inquiry on your credit, which could affect your credit score. Given this, you shouldn't apply for preapproval until you're serious about buying a home. This will both protect you from impairing your credit score unnecessarily and ensure that your preapproval is valid when you're ready to make an offer; a home-loan preapproval letter is typically only good for 30 to 60 days.

Having multiple preapproval letters from a few different lenders will only strengthen your hand. And if you get multiple inquiries for the same type of credit within a short period of time, the credit bureaus will usually treat those as one inquiry and avoid knocking your credit score.

How to get preapproved for a mortgage 

The process for getting a mortgage preapproval is fairly straightforward, and the better prepared you are, the more smoothly and quickly it will go.

Step 1: Review your financial situation

Before you apply for preapproval, it's a good idea to assess your current financial situation. 

Pull your credit report: Under normal circumstances, you're entitled to one free report from each bureau every 12 months, but you can now get a free credit report every week through April 2021. (Note that pulling your own report doesn't impact your score.) Review your credit history to make sure everything is accurate; you can reach out to lenders and the credit bureaus to make corrections if need be

Calculate your debt-to-income ratio: A key factor in getting prequalified for a mortgage, your DTI ratio represents your total monthly debt payments as a percentage of your monthly income. Most lenders won't offer a loan that will put your DTI above 43%. So, if you currently have an auto payment of $300, monthly minimum credit card payments of $65 and a monthly income of $5,000, your lender will only approve you for a mortgage with a monthly payment of $1,785.

Step 2: Submit your documents

For an official prequalification, lenders won't simply take your word for it when it comes to your income and liabilities. You need to show proof. Each lender may have different requirements, but here are some documents and information you will usually need to submit for yourself and anyone else on the loan application:

  • Your employment history (and contacts for verification)
  • Pay stubs from the last 30 days
  • Bank statements from the last two months
  • W-2s and possibly tax returns from the last two years
  • Insurance agent contact information and declarations
  • Outstanding debt information (your lender can usually just pull this from your credit report)
  • Business financial statements and tax returns (if you're self-employed)
  • Expected down payment (this affects your loan terms, interest rate and potential private mortgage insurance)

Self-employed individuals may have to provide additional paperwork to demonstrate proof of long-term income. Additional documents required often include:

  • Profit and loss statements
  • Business licenses
  • Tax returns and bank statements from the past two years
  • Balance statements

Not all lenders will require all of this information for preapproval, but you'll need to provide it at some point before your loan becomes official. And having all of it prepared may speed up the process.

Step 3: Lender review of credit and documentation

Next, your lender will review all of your documents, pull your credit report and seek to verify all of your information. This may include calling current and previous employers to verify your employment and wages, confirming outstanding loan amounts and investigating unusual transactions on your bank statements. Normally, this process should take no more than a few days.

Step 4: Get your home loan preapproval (or rejection) letter

Once your lender has completed its review, you'll receive the verdict. If there are no serious issues, you'll receive a preapproval letter indicating your maximum loan amount, estimated interest rate, loan type and terms. You'll want to give this letter to your real estate agent so they'll have it ready to submit with any offer.

What to do if you're declined for a preapproval

There's always a chance you won't get preapproved for a mortgage. But don't be disheartened. One rejection doesn't mean you can never get a mortgage. Especially during the pandemic, some lenders have tightened their standards for credit scores, down payments and more. But that won't last forever.

"We've been seeing these restrictions starting to soften as the market starts to recover and the economy becomes more accustomed to a completely virtual way of life," Watters said.

If you do get rejected, be sure you try applying with another lender. If one lender denied you for a credit score of 690, you can probably find a lender that's still qualifying borrowers for a conventional loan at 620 and above.

If you apply with a few lenders and still can't get preapproved, don't lose heart. Under the Equal Credit Opportunity Act (PDF), your lender has to tell you why your application was denied. It may have been your credit score, or it may be that you haven't been at your current job long enough. Whatever the reason is, now you know what to work on so you can get preapproved in the future.

What are the pitfalls?

Getting approved is usually pretty straightforward, but there are opportunities for things to go sideways. Here are a few things to avoid.

Applying when you're not really ready: If you already know your credit isn't great or you have too much debt, don't waste time applying for preapproval (and hurting your credit even more in the process). Make a plan to rebuild your credit to enhance your chances in six to 12 months from now.

Assuming your terms are final: Again, getting preapproved for a mortgage is not the same as officially having your loan underwritten and secured. Your terms can change. For instance, unless your rate is locked for 30 or 60 days, your final rate may vary, albeit slightly. If any information you provided wasn't accurate, that could change your final terms, too.

Taking on new debt between preapproval and underwriting: For that matter, your own financial choices can change your loan terms or derail the loan altogether. Once you're preapproved, it's time to wait on any big financial changes. That means no changing jobs, no new credit cards, no major purchases such as a new car.

Waiting too long after preapproval: Your loan preapproval is usually only good for 30 to 60 days. Once you have a letter, it's time to start house hunting and getting ready to make an offer. Otherwise, you may have to restart the process.