If you're planning to buy a home, securing a mortgage preapproval is an important first step. Preapproval gives you a clear sense of how much house you can afford based on your financial situation. It also makes you a more serious buyer in the eyes of sellers, since it means a lender has already reviewed your finances and issued preliminary approval for a home loan.
While preapproval isn't a guarantee of a mortgage, it's as close as you can get before locking it in. If you're serious about buying a home, get preapproved before you start house hunting so you can move quickly when you're ready to put in an offer. Here's more on how preapproval works.
What is mortgage preapproval?
Mortgage preapproval is a letter from a lender stating that you qualify to borrow a certain amount
of money to buy a home. It's not a guarantee of a mortgage, since your circumstances could still change between the time you get preapproved and apply.
But it's as close as you can get to full approval, since the lender reviews your finances in detail before issuing a preapproval. They typically ask for documentation on your income, debt and assets, as well as review your credit with a hard credit inquiry.
"Preapproval is much more than an online calculator or quick estimate," says Denver-based mortgage broker Chris Cartwright. "It means the lender has reviewed actual documents and stress tested the buyer’s financial profile upfront."
Getting your preapproval letter not only gets you one step closer to securing a mortgage, but it also helps you understand your home-buying power. You'll have a clearer sense of your estimated price range and interest rate before you make an offer on a house.
Why preapproval matters when buying a home
Getting a mortgage preapproval isn't strictly necessary when buying a home, but it can help you out in several important ways, such as:
- Helps you establish a realistic budget: You'll have a clear sense of how much you can borrow and your potential interest rate, which helps you stick to homes in your price range. You won't waste time viewing properties that are outside your budget.
- Identifies potential financial issues early: Because the lender reviews your credit, income, debt and savings, this process may reveal obstacles that could stand in the way of getting a mortgage. If it does, you can address those issues before you apply.
- Can strengthen purchase offers in a competitive market: Sellers may prefer homebuyers who have preapproval, since it shows you've started the mortgage process and are highly likely to secure a loan.
- Demonstrates seriousness to sellers and real estate agents: A preapproval letter shows that you're serious about buying, have taken steps to understand your borrowing power and are ready to move forward when you find the right home.
Pros and cons of mortgage preapproval
Getting mortgage preapproval is generally essential before making an offer on a home, though there are a few cons along with the pros.
Pros
- Helps determine affordability: You'll get a clear sense of how much house you can afford.
- Identifies issues early: The process may reveal problems with your finances that could stand in the way of getting a mortgage, which gives you time to address them.
- Strengthens offers: Sellers will see that you're likely to get a mortgage so they won't have to worry about the transaction falling through.
- Speeds up the homebuying process: Since the lender reviews your finances thoroughly during the preapproval process, it may be able to move faster during the formal mortgage application.
Cons
- Requires documentation: You'll have to provide documentation like pay stubs, W-2s and bank statements.
- May trigger a hard credit inquiry: Lenders typically run a hard credit check, which can ding your credit score by a few points.
- Expires after a limited period: Preapproval letters don't last forever — they usually expire after 30 to 60 days.
- Not a guarantee of final approval: Preapproval doesn't guarantee a home loan. The mortgage underwriter will still need to review your most updated financial and credit details and confirm the property qualifies for a loan.
How the mortgage preapproval process works step by step
Here's how to get preapproved for a mortgage, step by step.
- Compare lenders: Start by shopping around, since different lenders may offer different rates and requirements. According to Freddie Mac, getting one additional quote saves homebuyers an average of $1,500, while getting five more quotes saves an average of $3,000.
- Submit an application: Your next step is filling out and submitting the lender's application, which will ask for your personal and financial information.
- Provide documentation: The lender will need evidence of your assets and debts. Some common documents include pay stubs, W-2s or tax returns, bank statements, identification and proof of any additional income or assets
- Lender reviews your finances: The lender will review your finances, including your income, employment history, assets, savings, existing debt and credit history.
- Receive a preapproval decision: Once the lender has reviewed everything, it will give you its decision. Once you've made it through the mortgage preapproval process, you'll get a letter that you can include with any offers you make on homes.
What do lenders look for during preapproval?
During preapproval, mortgage lenders review your finances to determine how much you can afford to borrow. Here are some common mortgage preapproval requirements.
Credit score
Your credit score indicates how you've managed credit in the past. It's based on several factors, including your history of paying debts on time and credit utilization. A high score indicates that you're a reliable candidate for a loan and can help you qualify for lower interest rates. A low score makes you look riskier and can limit your borrowing options or stick you with higher interest rates.
Income and employment
Lenders also want to verify that you have a stable employment history and income. This suggests you'll be able to pay back your loan on time each month.
Debt-to-income ratio (DTI)
Your debt-to-income ratio compares your monthly debt payments with your gross income. If you make $4,000 per month and pay $1,000 toward debt, for example, your DTI would be 25%. Lenders consider your DTI to ensure you can afford a mortgage and won't be overextending your finances.
Lenders generally prefer a DTI of 36% or less, but some may allow ratios up to 50% if you have strong credit and cash reserves.
Assets and savings
Finally, lenders review your assets and savings to confirm you can cover a down payment and closing costs, along with any emergencies that may pop up. You can usually make a down payment as low as 3% or 5% for a conventional mortgage. Closing costs also usually add about 2% to 5% to your costs.
How long does mortgage preapproval take?
The timeline for mortgage preapproval varies.
"Preapproval can happen in a matter of hours if the borrower is organized, but more complex files can take a few days," says Cartwright.
Some factors that can affect the timing include:
- Type of lender: Online lenders may move faster than traditional banks.
- Your financial situation: A more complicated situation may take longer for a lender to sort through than a straightforward one.
- Your documents: The lender can move more quickly if you submit all the required documents from the start. It will take longer if you're missing any documents.
How long does a mortgage preapproval last?
A mortgage preapproval typically expires after 30 to 60 days. Lenders limit how long a preapproval is good for because financial situations can change. After this amount of time, they'll want updated information and documentation to renew your preapproval. If you've taken on new debt or your credit score has changed, you may no longer qualify for the same preliminary loan amount or interest rate.
What can hurt your chances after preapproval?
After you get preapproved, avoid making any major financial changes in your life. Some actions that could hurt your chances of locking in the final mortgage include:
- Taking on new debt
- Opening new credit cards
- Financing a vehicle
- Missing payments on your debts
- Changing jobs unexpectedly
"My advice is simple: once you’re preapproved, treat your finances like they’re in lockdown until closing," says Cartwright. "Don’t take on new debt, don’t make large purchases and don’t make major financial moves without talking to your lender first."
Lenders will reassess your situation before granting final approval, so any major changes could impact your eligibility.
Why final approval can differ from preapproval
Your final approval on a mortgage could differ from preapproval for a few reasons. A decrease in your income or credit score, for example, could mean you end up with a lower loan amount or higher interest rate. If you take on new debt, the lender may also reduce your mortgage offer.
"I tell clients all the time: preapproval gets you in the game, but consistency gets you to the closing table," Cartwright says.
The property you're trying to buy also must meet lender requirements and undergo an appraisal to determine its market value. If the appraisal comes in lower than your purchase offer, you may need to cover the difference yourself or renegotiate with the seller.
Tips to improve your mortgage preapproval odds
As you prepare for preapproval, here are a few tips for strengthening your application:
- Check your credit before applying: Find out what your score is, and review your credit report for any errors you can dispute. If you have time, take steps to improve your credit score before applying.
- Pay down high-interest debt: Paying down debt will improve your DTI and leave more room in your budget for mortgage payments. Reducing credit card balances can also lower your credit utilization, which can improve your credit score.
- Save for a larger down payment: A larger down payment can snag you a better interest rate. If you can put down 20%, you can avoid private mortgage insurance (PMI).
- Avoid major financial changes: Don't open new credit accounts or leave your job, for example, during the home-buying process.
- Organize documents ahead of time: Get all your documentation in order to make the process go as smoothly as possible.
- Compare multiple lenders: Shop around to find a home loan with the lowest rate and fees. You can start by prequalifying, which won't impact your credit. When it comes to preapproval vs. prequalification, prequalification is a faster first step that can give you a general sense of your rates and terms.
Bottom line
Mortgage preapproval is an important step along the home-buying journey. It will help you understand your buying power and spot any financial issues early. Including a preapproval letter with your home offer also shows sellers you're a serious buyer who's likely to secure a mortgage.
Understanding how the preapproval process works and preparing everything ahead of time can make the process go smoothly. Once you have your letter in hand, you'll be ready to put in an offer when you find the right home.
Mortgage preapproval FAQs
Does mortgage preapproval hurt your credit score?
Mortgage preapproval can hurt your credit score because it involves a hard credit inquiry. However, according to myFICO, your score should only drop by five points or fewer.
What documents do I need for mortgage preapproval?
Common documents for mortgage preapproval include pay stubs, W-2s, bank statements, proof of additional income or assets and identification.
Is mortgage preapproval required before buying a house?
Mortgage preapproval is not required before buying a house, but it can help you understand your buying power and make your offer more appealing to a seller.
Can I get denied after being preapproved for a mortgage?
You can get denied after being preapproved, especially if your financial situation or credit changes between the time you get preapproved and apply for the mortgage. The home you're looking to buy also must meet lender requirements.
This article originally appeared on USA TODAY: How mortgage preapproval works: A beginner's guide
