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By Jamie Smith
When shopping for a home, it's essential to go in knowing how much you can afford to borrow and what kind of homes are in your budget. Most sellers prefer home shoppers to have a mortgage preapproval letter, and they will be more likely to negotiate with those who demonstrate the ability to get financing. Let's take a look at what it means to get preapproved for a mortgage and how to get started.
Mortgage preapproval is the process of determining how much money you may borrow to buy a property. To get preapproved, lenders look at a variety of documents regarding your income, assets, and credit score to decide what loans you may be eligible for, how much you may borrow, and what your interest rates may be. Understanding how mortgage preapproval works and doing some homework ahead of time will help you when you're ready to buy.
Once you are preapproved, you'll receive an electronic and/or physical copy of your preapproval letter. The document details the type and amount of loan for which you have been accepted and other pertinent information.
You've probably heard it said that if you're ready to become a homeowner, you should be preapproved for a mortgage. However, you likely still have some questions about preapproval, so let's answer the most common ones.
Preapproval and prequalification are two methods of determining borrower eligibility. Although some use these phrases interchangeably, they are not the same procedures when speaking with lenders. Let's clarify everything once and for all.
When you're not sure if you're financially equipped to buy a home, prequalification is a great place to start. Prequalification usually means a faster, more casual evaluation of your financial position compared to a more comprehensive preapproval. When you prequalify for a home loan, you’re getting an estimate of what you might be able to borrow, based on information you provide about your finances as well as a credit check.
If you get a thumbs up during prequalification, you'll generally go on to preapproval. A lender then evaluates your credit record and reviews documents thoroughly to verify your income, assets, and responsibilities. This is standard procedure for the home mortgage preapproval process.
The two terms can be used interchangeably, but they aren't the same. The easiest thing to remember is that you usually get prequalified before a preapproval. Prequalification is informal and does not lead to any tangible documents, while a preapproval ends with a preapproval letter. If you're confident in your credit and financial readiness, it's generally OK to skip the prequalification stage and proceed directly to getting the best preapproval letter you can.
After submitting a loan application, provided everything goes smoothly, you can obtain a preapproval letter. It can take up to a few days, however, so be sure to provide everything the lender wants. You will need to have the following ready:
You might also want to include the most recent end-of-year pay stub if your income includes bonuses or overtime. Each lender will have its own process and requirements. The point is getting a deeper image of your credit history. The lender uses that information to calculate much you can realistically afford to borrow and pay back in monthly payments. Depending on the amount of work associated with your papers, reviewing your application might take several days. If you meet the requirements, you will be given a preapproval letter.
Want to cover all your bases and get the best result out of your mortgage preapproval? Follow these tips:
Before contacting a lender, you should be aware of your current situation so you don't face any difficult surprises. It is suggested that you have a credit score of at least 620 before trying to apply for a home mortgage, as the higher the score, the more likely you are to get more generous interest rates and terms. Most consumers will be able to qualify for the best mortgage rates on the market with a credit score of 740 or above.
Request copies of multiple credit reports to verify your score. You might want to file a dispute if there appear to be any mistakes. If you discover outstanding accounts, communicate with creditors to rectify the issues before applying.
The debt-to-income ratio, or DTI, is the percentage of your gross monthly income that goes toward debt payments. Don't neglect anything that qualifies as a debt, such as payments for credit cards, co-signing on a loan for someone else, school loans, and vehicle loans. Debt-to-income ratio calculators will help you estimate your DTI based on existing bills and a potential mortgage. Borrowers with a DTI of 36% or less, including the mortgage, are preferred, but you could still get approval with a higher DTI.
Beyond pay stubs, you should have your own and any co-borrower's Social Security numbers, current residences, and work information. You'll also need details about your bank and investment accounts, as well as evidence of income. You'll need your W-2 tax form, if applicable, and 1099s if you have extra income sources. Two years of continuous employment is desirable. Self-employed candidates should furnish two years of tax returns, if not more. Finally, if your down payment is the result of a gift or the sale of an asset, you'll need documentation to verify that. A gift letter for a mortgage down payment is a note from the donor that states you don’t have to pay the money back. If you’re using gift money for part -or all- of your down payment, you’ll need the donor to write a gift letter to your mortgage company that makes it clear that the money is a gift and not a loan.
A home is one of the biggest purchases a person could make. Comparing rates and fees from various lenders can help you save thousands of dollars. Fair Isaac Corporation (FICO) says that when shopping for a home loan, you have 30 days to make further inquiries that will not affect your scores while rate shopping.
Typically, mortgage preapproval letters are good for 60 to 90 days. Because your finances may change, lenders include an expiration date on the letter. When a preapproval expires, you must complete a new application. This way, sellers can be confident that the assessment of your financial situation is still accurate.
If you're just starting to consider purchasing a house and feel you'll have trouble getting a mortgage, it may be best to go through a longer-term credit cleanup. Seeking preapproval six months to a year before embarking on a serious property hunt might help you understand your credit score better and also how much you may want to focus on improving it. It'll also give you extra time to save for a down payment and closing charges.
Searching for a home is fun, but if you want to afford that perfect place, you'll want to walk in with the best credit and financing possible.
Looking for the perfect home? Alliant has mortgage loan options to fit any budget.
Want to learn more about mortgages? Check out these other articles:
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