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How to get preapproved for a mortgage
What you need to know to start your homebuying process on the right foot.
If you’re house-hunting and have a preapproval letter in-hand, you’re already a cut above others who might be looking at the same property. And getting preapproved for a mortgage isn’t as daunting as it might seem.
The key is to be prepared so you know exactly what to expect and what documents you’ll need every step of the way.
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What is a mortgage preapproval?
A mortgage preapproval is a letter from a lender stating a specific monetary amount that they’ll lend you for the purchase of your home. This is based on a number of factors, including your income, debt and credit score.
Getting preapproved is beneficial for several reasons. Most importantly, you’ll have an accurate idea of how much you can actually afford to spend on a new property. Having a preapproval letter can also give you an advantage over other buyers.
Bringing a preapproval letter to a buyer or real estate agent shows that you’re prepared and serious about making a purchase. It proves that you can get a loan for at least the asking price of the house or property.
How do I get preapproved for a mortgage?
To get the ball rolling with your homebuying process, start with these three steps:
- Start by checking your credit score and evaluating your debt-to-income ratio (DTI) so you know where you stand. Calculate your DTI by dividing your total recurring monthly debt by your gross income.
- Find a lender. Banks, credit unions and online financial institutions are the most common types of lenders. Talk to more than one so you can compare rates, fees and loan options.
- Get preapproved. Work with your lender to provide all necessary documents and information quickly so you can get your preapproval as soon as possible.
Get a preapproval from one of these lenders
Requirements to get preapproved
Have these documents ready for your lender for a more seamless preapproval process:
- Income. Lenders look at your debt-to-income ratio to determine how much you can afford to spend on a house. Most lenders want your total debt, including your new home loan, to be no more than 43% of your total income.
- Proof of assets. If you have any assets like stocks, bonds, savings accounts, retirement accounts, or equity in another property, your lender will want to see documentation for them.
- Good credit. The higher your credit score, the better your chances of being preapproved for a mortgage and getting a good rate. The minimum credit score to get a mortgage depends on the type of loan you’re getting.
- Employment verification. Lenders ask for verification of employment in the form of pay stubs and your most current W-2 forms. If you’re self-employed, you’ll need to provide at least two years of tax returns to verify your income.
- Residence history. Lenders may ask for proof of your residency for the past two years. This could be a letter from your landlord if you rent, or proof of your current mortgage if you already own a home.
Other documents you may need to provide
Most lenders will require these documents when you apply for a mortgage:
- 60 days of bank statements.
- Schedule K-1 (Form 1065) for self-employed borrowers.
- Income tax returns.
- Driver’s license or US passport.
- Divorce papers to use alimony or child support as qualifying income.
- Gift letter, if funding your down payment with a financial gift from a relative.
- Third-party bank statements, if someone else pays for a considerable amount of your debt, such as parents paying for student loans.
What factors are considered during a preapproval?
Your lender takes the following into consideration when working on your preapproval:
- Debt-to-Income Ratio (DTI). This is one of the most important factors that lenders consider. To find your DTI, divide your total amount of recurring monthly debt by your gross monthly income. Note that recurring monthly debt typically only includes monthly payments that show up on a credit report — credit cards, car payments, student loans — and not utilities or similar payments.
- Loan-to-value ratio (LTV). This is the amount of money you’re borrowing, compared to the appraised value of the property. A higher LTV is riskier for lenders.
- Credit history and FICO score. Most lenders look at your FICO score before approving you for a mortgage. The higher your score, the more likely it is that you’ll be preapproved and get a better interest rate.
- Income and employment history. Lenders want to know that you have stable employment and have enough income compared to your debt to afford your monthly mortgage payments.
What if I’m self-employed?
Self-employed borrowers are treated a bit differently than other borrowers. You’ll need to have at least two years of tax returns that show your business income. If you’ve only been self-employed for one year, most lenders won’t preapprove you unless you have significant alternative sources of income, a cosigner or a spouse who could put the home in his or her name.
You’ll also need to show proper documentation, such as 1099 forms from clients or a Schedule K-1 (Form 1065). If you don’t have two years of tax returns for your business, you could get preapproved if you have someone who’s willing to cosign for you.
Keep in mind that any business expenses that you write off for tax purposes is deducted from your total income, which can put you at a disadvantage when applying for a mortgage. While you should take advantage of eligible tax write-offs for your business, you may want to pick and choose what you write off if you know you’ll be applying for a mortgage.
I’m preapproved. Now what?
Once you’re preapproved, keep a close eye on your finances until the entire mortgage process is complete. Any changes to your financial situation from the time you’re preapproved to the date of your closing can impact your ability to finalize the loan.
- Avoid changes in income. Don’t quit or change jobs in this timeframe.
- Avoid accumulating new debt. Now is not the time to buy a new car or finance living room furniture.
- Make payments on time. Late or missed payments affect your credit score, and a lower credit score might affect your mortgage eligibility.
- Stay in touch with your lender. Keep your lender in the loop when you’re ready to make an offer on a property, especially if any numbers have changed since you last spoke.
Bottom line
Getting preapproved for a mortgage is a helpful first step in the homebuying process and can help you edge out the competition. But it’s important to do your diligence ahead of time to help make the process as smooth as possible and ensure that you get the best rate and terms available.
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