You've probably heard of the preapproval process, but you may not know or fully understand what it actually means. Let's dig into the process and some frequently asked questions.
What Is Preapproval?
Preapproval means a lender makes a call on whether a potential home buyer is eligible to qualify for a home loan and how much they can qualify for. The lender comes to these conclusions based on proof of finances provided by the potential buyer. Note that preapproval doesn't guarantee loan approval, but it's a step in the right direction.
Why Should I Get Preapproval?
Preapproval not only is necessary but also benefits you. Buyers often don't realize how much money they’ll need to put down and how that relates to how much house they can afford. The amount of a down payment affects a buyer's monthly payments, mortgage insurance, and so on.
By working with a lender, you can explore different scenarios to help you decide on critical factors like house cost and size. For example, you may think you’ll save money by buying a smaller condo. But after factoring in monthly homeowner association assessments (monthly dues you pay), you might find that a single-family home is more affordable.
Or, a buyer may think a loan product their friend used will work the same for them. Although that's possible, it's a risky assumption. No two loans are alike, just as no two people’s finances and life circumstances are the same.
Loan products have different costs in areas such as lender origination fees. You can work with a loan officer to learn the cost of a loan, how the loan process works, and which products are the best options for you. While your costs might not be exact at this stage, you can get a good idea of what to expect.
Looking for homes armed with this information about what you can afford is an important reason to seek preapproval. And itl shows sellers you're serious and prepared to make an offer. In some competitive markets, sellers won't even consider an offer unless a preapproval letter comes along with it.
Related: How to Choose a Mortgage Lender
How Hard Is the Preapproval Process?
Preapproval is relatively simple. You need to know your financial situation — how much money you consistently make, your assets, how much debt you have, and the sources of those debts. You need to articulate and substantiate that information clearly to your lender. You'll basically complete a mortgage application, and the lender will verify the information you provide.
What Will My Lender Need to Check During Preapproval?
- Your credit score. Yes, your lender will then have to pull your credit. Don’t worry, pulling your score once shouldn’t affect your score.
- W2s or 1099s.
- Pay stubs.
- Tax returns.
- Bank statements.
- Account statements.
- Your list of monthly expenses.
Gathering all these documents can feel like busy work and is typically the hardest part for you.
If you want an idea of your chances for preapproval before choosing a lender, a good first step is finding out your debt-to-income ratio, or DTI. Your DTI helps a lender understand how much of your monthly income goes to paying debt and what funds remain afterward. You can calculate the ratio by dividing monthly debt payments by gross monthly income.
A lower DTI ratio will make you seem less risky to lenders, so the lower it is, the better. Although each loan product varies, most lenders would prefer a debt-to-income ratio of 36% or lower.
A simple worksheet can help you easily figure your own debt-to-income ratio. You can download and print yours here.
What Comes After Preapproval?
If a lender doesn't preapprove you, it can signal that you aren't ready to buy a house yet. In that case, work with your lender to identify what you need to change or improve before trying again.
But if a lender preapproves you, you can start the fun part!
With your preapproval letter, you can confidently look for homes with the help of your real estate agent. When a seller accepts your offer on their home, you’ll officially apply for a loan, and the lenders will go over all your documents again.
Note that you have the option to choose a lender other than the one that granted your original preapproval. In fact, once a seller has accepted your offer, it’s a good idea to request a loan estimate from two to three lenders and compare them to find the best terms for you. You'll want to consider loan fees, interest rate, and annual percentage rate.
By the way, APR (annual percentage rate) is a good measure of your loan costs because it’s a broader picture of your costs than the interest rate. It takes into account points and mortgage fees, among other things. So, it will be higher than the interest rate.
The lender will let you know how much time you can take to decide on a mortgage before your loan offer expires. Once you decide on a lender, it’s time to go and buy your dream house!
Remember that help is available. One of the many reasons to choose a professional loan officer and a qualified real estate agent is they can explain the process. They'll walk you through the steps to the door to your new home.
Related: How to Get Home Financing
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