If you are in the market for a new home, chances are you’ve come across the term “mortgage pre-approval.” Understanding the definition of a mortgage pre-approval, the steps necessary to get one and what it means to you as a homebuyer are important concepts that you’ll want know before you take another step in the process of purchasing a home. You’ll find all the information you need to know in this comprehensive pre-approval guide. 

What is a Mortgage Pre-Approval?

what is mortgage pre-approval
A mortgage pre-approval is issued by a lender, bank or other financial institution. It is the culmination of research by that institution. It involves looking at your credit history, income and financial information, as well as other factors, based on information you provide.

Having a mortgage pre-approval letter in hand means that the lender is willing to offer you a loan in the amount noted. In many cases, this mortgage pre-approval letter is valid only for a certain time frame. 

The Importance of a Mortgage Pre-Approval

the importance of mortgage pre-approval
A mortgage approval letter is important for many reasons. Having it in your possession means that you have undergone the necessary process outlined by your lender.

The result is that a lender is confident that you are able to repay the loan based on the information you gave them. You’ll enjoy the following advantages of having one: 

Real estate agents

As a busy professional, your real estate agent wants to make that you are serious about purchasing a new home.

One of the best ways of demonstrating this commitment is to arrive at your first meeting with your real estate agent with a copy of a mortgage pre-approval letter. In fact, today, many real estate professionals hesitate to work with potential home buyers unless they come equipped with a mortgage pre-approval letter. 

Sellers

The housing market is improving across the country. Depending on the area where you want to move, you could find that there is some competition for homes located in highly-desirable neighborhoods.

A seller might have several offers on the table. Yours will stand out from the crowd because of the attractive mortgage pre-approval letter included with it. 

Check for mistakes

Since your credit history will be checked by the lender anyway — which typically doesn’t make much of a hit on your score unless you apply for several over the period of a few days — this is the perfect time for you to obtain a free copy of what they are seeing.

The primary reason for this is so you can note any errors or discrepancies and correct them. Depending on what type of errors they are, you might be able to get them cleared up before you apply for your mortgage. At the very least, you can inform your lender that you are in the process of addressing them. In case you need to get your credit score higher, follow this guide.

Your budget is clear

By being pre-approved for a mortgage, you’ll know exactly how much house you can afford as well as your estimated monthly payments. At this stage of the home buying process, knowing how much home your lender has determined that you can afford gives you with a ballpark figure.

You can save valuable time by focusing on homes within your price range. This could also be a time when you can solidify your short list of deal breakers and rework it, if necessary.

Knowing what your mortgage is likely to be each month also enables you to project your budget into the future. For example, that fixer-upper that seems like a good bargain now — and it fits into your budget — might need a new roof in five years. Knowing that information, you can determine whether or not you’d have the money to spring for such a major expense just a few short years after you purchase the home. 

Process of Obtaining a Mortgage Pre-Approval

the process of mortgage pre-approval 
When you begin the process of obtaining a mortgage pre-approval, be prepared to gather a few pieces of financial information*. While the approval process is not an instanteous one, it doesn’t take a long time either. Because you’ll need much of the same information when you apply for a mortgage, a pre-approval is much like a test run for it. 

1. Assets Statement

One of the most important pieces of information that your mortgage pre-approval hinges on is your ability to pay the closing costs and make the down payment. You also need to have enough cash reserves to meet their lending formula.

Your lender will need to see copies of your most recent bank statements as well as any investment accounts that you might have. Just for perspective, a conventional mortgage typically requires a down payment of between 10 and 20 percent. In contrast, a FHA loan might require a down payment of only 3.5 percent. 

2. Income Statement

Knowing your current — and past — income provides the lender with some indication of whether or not you have the money you need to pay your mortgage payments on time — throughout the life of the loan.

Today, there are hardly any lenders that issue mortgage pre-approval letters without documentation or verification from a third party. Before you arrive at your lender for your appointment to apply for a mortgage pre-approval, make sure to gather together your tax forms from the past 2 years and your W-2 statements from the same time period.

You’ll also need recent pay stubs that not only show your current income, but also your income as of that date and any other kind of income — including, but not limited to — bonuses and alimony. 

3. Verification of Employment

In addition to the above information regarding your employment, your lender will likely want to contact your employer directly.

Some questions that you can expect your employer to be asked by your lender include whether or not you are still employed with that company and your exact salary. If you have changed jobs recently, your lender will likely need to invest in a bit of extra legwork to determine your eligibility.

This most often involves contacting your former employer. If you are self-employed, be prepared to provide a significant amount of documentation and paperwork concerning your business as well as your income. Your lender wants to make sure that you are a good credit risk before agreeing to a mortgage pre-approval letter. 

4. Legal Documents

Several forms of documentation will be required by your lender. In addition to obtaining copies of both your driver’s license and social security number so that your credit report can be pulled, you might be asked for other legal documentation to verify information that is unclear. 

5. Your Credit Report

Your credit report is the document that your lender uses to base your interest rate on. Those home buyers with an excellent credit score — generally agreed to be 740 and above — are rewarded with the lowest interest rates. Because they have tighten their mortgage requirements in recent months, lenders that work with FHA loans typically want to see that you have a credit score of at least 620.

If your credit score is below 580, you can expect to pay more in interest rates. It is also likely that you’ll need more money for a down payment. Many lenders try to work with their clients so they can often suggest methods of raising your credit score so you can enjoy more benefits. (Guide on Credit Repair)

Do You Need a Mortgage Pre-Approval?

do you need a mortgage pre-approval
In a word — yes! A mortgage pre-approval provides you with lots of good information that is useful when it comes to purchasing a home. Once you know where you stand with your lender, you can focus your search for a home more precisely.

You’ll also by able to present a seller with a rock-solid offer and demonstrate your sincerity to a real estate professional that is determined to find the right home for you. While a mortgage pre-approval is not a guarantee that your lender will provide you with a loan, it is a solid piece of groundwork onto which to build a long and thriving relationship.

*Pre-approvals are offered by Neighborhood Loans to clients that voluntarily provide the required documentation. Neighborhood Loans also offers pre-qualification options that require no documentation. This information pertains to pre-qualification, pre-approval processes only. Actual loan applications require standard documentation.