What is a mortgage preapproval?
A mortgage preapproval is a letter from a lender confirming the size of the loan you’ll be able to get.
To be considered for preapproval, you’ll need to provide evidence of your financial situation, including your income, existing debt, credit score and monthly expenses.
The amount of money you’re preapproved for basically determines the size and cost of the home you're able to buy.
'Preapproved' vs. 'prequalified'
"Prequalified" is not the same as "preapproved." A prequalification is an estimate of your mortgage loan potential based on general details about your financial status.
It's is not much more than a conversation about the size of the loan you’ll likely qualify for — but no official estimate is given by the bank.
On the other hand, a preapproval is an official estimate confirming your mortgage potential based on proof of income, proof of assets, and your credit score.
This is how much money a bank is actually willing to give you to finance your new home.
Why get preapproved?
Sellers don’t want to waste their time initiating a sale with a buyer who can't qualify for a mortgage. A preapproval letter proves you’re a serious buyer and that you have the money to back it up.
Today, preapproval letters are more or less mandatory if you want to get the ball rolling on a home purchase.
Use our calculator to find out how much home you can afford .
4 steps to preapproval
1. Have your credit checked. You will need to provide your Social Security number and driver’s license. (Same goes for your partner, if it's a joint application.)
The lender will do a hard pull on your credit report to check your credit score and credit repayment history. Borrowers with a credit score below 580 are typically required to make a larger down payment.
Be aware that having a short credit history timeline or no credit history at all can be just as bad — or even worse — than having a low credit score.
2. Show you can make a down payment. Next, you’ll need to prove you have the money for a down payment on the home.
Down payments range from 3.5% for FHA loans to as much as 20% for conventional home loans.
If you don’t have the funds or liquid assets to cover the down payment, then you’ll need to provide a gift letter from a friend or relative who can cover the cost.
3. Provide proof of income. The lender will want to make sure you have the income to afford monthly mortgage payments.
If you’re employed by a company (other than your own), the lender will likely ask for recent pay stubs, year-to-date income, a copy of your W-2 statements from the last two years, and proof of any additional income.
If you're self-employed, you may need to provide additional paperwork.
If you’ve changed jobs recently, the lender may ask for verification of the income you earned through your previous employer.
4. Be open about monthly expenses. Lenders also are curious about the full extent of your assets and monthly expenses.
Potential borrowers who are already paying steep monthly expenses will be less likely to be approved if they don’t have financial assets substantial enough to comfortably cover a mortgage payment, too.
After this process, you’ll walk away with a document that proves you can afford a mortgage. Experts recommend getting preapproved before you even start looking at real estate, or as early as possible in your search.
This will ensure that when you do find your dream home, you’re not left scrambling and potentially losing out to another buyer who comes with paperwork ready.
Plus, getting preapproved means you’ll know the upper limit of what you can spend. You’ll be safe from taking on more house — and more house debt — than you can afford.
Follow us on Twitter: @moneywisecom