As you search for a home, getting preapproved for a mortgage is an important step to take. Consulting with a lender and obtaining a preapproval letter provides you with the opportunity to discuss loan options and budgeting with the lender, which can help to clarify your house-hunting budget and the monthly mortgage payment you can handle. Potential buyers should be careful to estimate their comfort level with a given house payment rather than immediately aim for the top of their spending limit.

Before lenders decide to preapprove you for a mortgage, they will look at several key factors:

  • Your credit history
  • Credit score
  • Debt-to-income ratio
  • Employment history
  • Income
  • Assets and liabilities

Think of a mortgage preapproval as a physical exam of your finances. Expect lenders to poke and prod into all corners of your financial life to ensure you’ll repay your mortgage. As a borrower, it’s important to know what a mortgage preapproval does (and doesn’t do), and how to boost your chances of getting one.

Key Takeaways

  • Going through the preapproval process with several lenders allows a home buyer to shop interest rates and find the best deal.
  • A seller often wants to see a mortgage preapproval letter and, in some cases, proof of funds to show that a buyer is serious.
  • The first step is filling out a mortgage application and supplying your Social Security number so the lender can do a credit check on you.
  • You'll also need to provide extensive documentation of job history, assets and liabilities, income tax returns, and more. Self-employed buyers may need to provide additional documentation.
  • After reviewing your application, a lender will offer preapproval or preapproval with conditions, or deny preapproval.

Prequalification vs. Preapproval

You’ve likely heard the term “prequalification” used interchangeably with preapproval, but they are not the same. With a prequalification, you provide an overview of your finances, income, and debts to a mortgage lender who then gives you an estimated loan amount. In this way, a mortgage prequalification can be useful as an estimate of how much you can afford to spend on a home. However, the lender doesn’t pull your credit reports or verify your financial information. Accordingly, prequalification is a helpful starting point to determine what you can afford but carries no weight when you make offers.

A preapproval, on the other hand, involves filling out a mortgage application and providing your Social Security number so that a lender can do a hard credit check. A hard credit check is triggered when you apply for a mortgage, and a lender pulls your credit report and credit score to assess your creditworthiness before deciding to lend you money. These checks are recorded on your credit report and can impact your credit score. (By contrast, a soft credit check occurs when you pull your credit yourself, or when a credit card company or lender preapproves you for an offer without your asking. Soft credit checks do not impact your credit score.)

Also, you’ll list all of your bank account information, assets, debts, income and employment history, past addresses, and other critical details for a lender to verify. Why? Above all, a lender wants to ensure you can repay your loan. Lenders also use the provided information to calculate your debt-to-income and loan-to-value ratios, which are essential factors in determining the interest rate and ideal loan type.

All of this makes a preapproval much more valuable. It means the lender has checked your credit and verified the documentation to approve a specific loan amount. Final loan approval occurs when you have an appraisal done and the loan is applied to a property.

When to Get Preapproved

Mortgage preapproval letters are typically valid for 60 to 90 days. Lenders put an expiration date on these letters because your finances and credit profile could change. When a preapproval expires, you’ll have to fill out a new mortgage application and submit updated paperwork to get another one.

If you’re just starting to think about buying a home and suspect you might have some difficulty getting a mortgage, going through the preapproval process can help you identify credit issues—and give you time to address them. Seeking preapproval six months to one year in advance of a serious home search puts you in a stronger position to improve your overall credit profile. You’ll also have more time to save money for a down payment and closing costs.

When you are ready to make offers, a seller often wants to see a mortgage preapproval and, in some cases, proof of funds to show that you’re a serious buyer. In many hot housing markets, sellers have an advantage because of intense buyer demand and limited homes for sale; they’re unlikely to consider offers without preapproval letters.

What You Need to Get Pre-Approved for a Mortgage
Emily Roberts {Copyright} Investopedia, 2019.

The Preapproval Process

Applying for a mortgage can be exciting, nerve-wracking, and confusing. Some online lenders can pre-approve you within hours, while other lenders could take several days. The timeline depends on the lender and the complexity of your finances.

For starters, you’ll fill out a mortgage application. You’ll include your identifying information, as well as your Social Security number to pull your credit. Although mortgage credit checks count as a hard inquiry on your credit reports and may impact your credit score, if you’re shopping multiple lenders in a short timeframe (usually 45 days for newer FICO scoring models) the combined credit checks count as a single inquiry.

Here’s a sample of a uniform mortgage application. If you’re applying with a spouse or other co-borrower whose income you need to qualify for the mortgage, both applicants will need to list financial and employment information. There are eight main sections of a mortgage application:

Type of mortgage and terms of the loan

The specific loan product for which you’re applying; the loan amount; terms, such as length of time to repay the loan (amortization); and the interest rate.

Property information and purpose of the loan

The address; legal description of the property; year built; whether the loan is for purchase, refinance, or new construction; and the intended type of residency (primary, secondary, or investment).

Borrower information

Your identifying information, including full name, date of birth, Social Security number, years of school attended, marital status, number of dependents, and address history.

Employment information

The name and contact information of current and previous employers (if you’ve been at your current position less than two years), dates of employment, title, and monthly income.

Monthly income and combined housing expense information

A listing of your base monthly income, as well as overtime, bonuses, commissions, net rental income (if applicable), dividends/interest, and other types of monthly income such as child support or alimony. Also, you’ll need an accounting of your monthly combined housing expenses, including rent or mortgage payments, homeowners and mortgage insurance, property taxes, and homeowner’s association dues.

Assets and liabilities

A list of all bank and credit union checking and savings accounts with current balance amounts, as well as life insurance, stocks, bonds, retirement savings, and mutual funds accounts and corresponding values. You need bank statements and investment account statements to prove that you have funds for the down payment and closing costs, as well as cash reserves.

You’ll also need to list all liabilities, which include revolving charge accounts, alimony, child support, auto loans, student loans, and any other outstanding debts.

Details of the transaction

An overview of the key transaction details, including purchase price, loan amount, the value of improvements/repairs, estimated closing costs, buyer-paid discounts, and mortgage insurance (if applicable). (Note: The lender will fill in much of this information.)

Declarations

An inventory of any judgments, liens, past bankruptcies or foreclosures, pending lawsuits, or delinquent debts. You’ll also be asked to state whether you’re a U.S. citizen or permanent resident and whether you intend to use the home as your primary residence.

Most homesellers will be more willing to negotiate with those who have proof that they can obtain financing.

What Happens Next?

A lender is required by law to provide you with a three-page document called a loan estimate within three business days of receiving your completed mortgage application. This paperwork notes whether the mortgage has been preapproved and outlines the loan amount, terms and type, interest rate, estimated interest and payments, estimated closing costs (including any lender fees), an estimate of property taxes and homeowner’s insurance, and any special loan features, such as balloon payments or an early prepayment penalty. It also specifies a maximum loan amount, based on your financial picture, to help you narrow down your home-buying budget.

If you’re preapproved for a mortgage, your loan file will eventually transfer to a loan underwriter who will verify your documentation against your mortgage application. The underwriter will also ensure you meet the borrower guidelines for the specific loan program for which you’re applying.

Documentation Needs

After submitting your mortgage application, you’ll need to gather a number of documents to verify your information. Preparation and organization on your end will help the process go more smoothly. Here’s a list of documents you need to present in order to be preapproved or to secure final loan approval before closing:

  • 60 days of bank statements
  • 30 days of pay stubs
  • W-2 tax returns from the previous two years
  • Schedule K-1 (Form 1065) for self-employed borrowers
  • Income tax returns
  • Asset account statements (retirement savings, stocks, bonds, mutual funds, etc.)
  • Driver’s license or U.S. 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)

Down Payment Gifts

Many loan products allow borrowers to use a financial gift from a relative toward the down payment. If you go this route, a lender will ask you to complete a standard gift letter in which you and the gift donor aver that the gift isn’t a third-party loan with an expectation of repayment. Otherwise, such an arrangement could increase your debt-to-income ratio, impacting your final loan approval. Additionally, both you and the donor will have to provide bank statements to source the transfer of cash funds from one account to another.

Factors Impacting Preapproval

If you want to maximize your chances of getting a mortgage preapproval, you need to know which factors lenders evaluate in your financial profile. They include your:

Debt-to-income ratio

Your DTI ratio measures all of your monthly debts relative to your monthly income. Lenders add up debts such as auto loans, student loans, revolving charge accounts and other lines of credit, plus the new mortgage payment, and then divide the sum by your gross monthly income to get a percentage. Depending on the loan type, borrowers should maintain a DTI ratio at or below 43% of their gross monthly income to qualify for a mortgage. The higher your DTI ratio, the more risk you pose to lenders because you could be more likely to struggle to repay your loan on top of debt payments. Having a lower DTI ratio can qualify you for a more competitive interest rate. Before you buy a home, pay down as much debt as possible. Not only will you lower your DTI ratio, but you’ll also show lenders that you can manage debt responsibly and pay bills on time.

Loan-to-value ratio

Another key metric lenders use to evaluate you for a mortgage is your loan-to-value ratio, which is calculated by dividing the loan amount by the home’s value. A property appraisal determines the property’s value, which might be lower or higher than the seller’s asking price. The LTV ratio formula is where your down payment comes into play. A down payment is an upfront sum of money you pay, in cash, to the seller at the closing table. The higher your down payment, the lower your loan amount and, as a result, the lower your LTV ratio. If you put down less than 20% percent, you might be required to pay for private mortgage insurance (PMI). It’s a type of insurance coverage that protects lenders in the event you fail to repay your mortgage. To lower your LTV ratio, you either need to put more money down or buy a less expensive house.

Credit history and score

Lenders will pull your credit reports from the three main reporting bureaus—Equifax, Experian, and Transunion. They’ll look for your payment history and whether or not you pay bills on time, how many and what type of credit lines you have open, and the length of time you’ve had those accounts. In addition to positive payment history, lenders analyze how much of your available credit you actively use, also known as credit utilization. Maintaining a credit utilization rate at or below 30% helps boost your credit score, and it shows lenders a responsible, consistent pattern of paying your bills and managing debt wisely. All of these items account for your FICO score, a credit score model used by many types of lenders (including mortgage lenders).

If you have not opened credit cards or any traditional lines of credit such as an auto or student loan, you might have trouble getting a mortgage preapproval. You can build your credit by opening a starter credit card with a low credit line limit and paying off your bill each month. It could take up to six months for your payment activity to be reflected in your credit score so be patient as you build your credit profile.

Most lenders require a FICO score of 620 or higher to approve a conventional loan, and some even require that score for a Federal Housing Administration loan. Lenders typically reserve the lowest interest rates for customers with a credit score of 760 or higher. FHA guidelines allow approved borrowers with a score of 580 or higher to pay as little as 3.5% down. Those with lower scores must make a larger down payment. Lenders will often work with borrowers with a low or moderately low credit score and suggest ways to improve their score.

The chart below shows your monthly principal and interest (PI) payment on a 30-year fixed interest rate mortgage based on a range of FICO scores for three common loan amounts. (Since interest rates change often, use this FICO Loan Savings Calculator to double check scores and rates.) Note that on a $250,000 loan an individual with a FICO score in the lowest (620-639) range would pay $1,362 per month, while a homeowner in the highest (760-850) range would pay just $1,128, a difference of $2,808 per year.

 

FICO score range

 

620-639

 

640-659

 

660-679

 

680-699

 

700-759

 

760-850

 

Interest rate

 

5.129%

 

4.583%

 

4.153%

 

3.939%

 

3.762%

 

3.54%

 

$350,000 loan

 

$1,907

 

$1,791

 

$1,702

 

$1,659

 

$1,623

 

$1,579

 

$250,000 loan

 

$1,362

 

$1,279

 

$1,216

 

$1,185

 

$1,159

 

$1,128

 

$150,000 loan

 

$817

 

$767

 

$729

 

$711

 

$696

 

$677

At today's rates and over the 30 years of that $250,000 loan, an individual with a FICO score in the 620-639 range would pay $240,260 in interest and a homeowner in the 760-850 range would pay $156,152, a difference of more than $84,000.

Employment and income history

When you apply for a mortgage, lenders go to great lengths to ensure you earn a solid income and have stable employment. That’s why lenders request two years’ worth of W-2s and contact information for your employer. Essentially, lenders want to ensure that you can handle the added financial burden of a new mortgage. You’ll also be asked to provide salary information, so a lender has evidence that you earn enough money to afford a mortgage payment and related monthly housing expenses. You’ll also have to provide 60 days (possibly more, if you’re self-employed) of bank statements to show you have enough cash in hand for a down payment and closing costs.

Loan Types

All but jumbo loans are conforming, meaning they conform to government-sponsored enterprise (Fannie Mae and Freddie Mac) guidelines. Some loans, such as HomeReady (Fannie Mae) and Home Possible (Freddie Mac), are designed for low- to moderate-income homebuyers or first-time buyers. Veterans Affairs (VA) loans, which require no money down, are for U.S. veterans, service members, and not-remarried spouses.

The chart below lists common loan types and the basic (and widely varying) requirements for each. In the DTI Ratio column, where two figures appear, the first refers to housing-only debt and the second to all debt. Under PMI/MIP/Fee, two numbers separated by a slash (/) indicate an upfront fee followed by an annual fee (paid monthly). All mortgage loans have additional requirements not listed here.

 

Mortgage

 

Min. Down

 

FICO

 

DTI Ratio

 

PMI/MIP/Fee

 

Add’l Requirements

 

Conventional 97

 

  3%

 

620

 

41%

 

0.15%-1.95%

 

 

 

Conventional

 

5%-20%

 

620

 

43%

 

0.15%-1.95%

 

 

 

Jumbo

 

5%-20%

 

720-740

 

43%

 

None

 

Nonconforming

 

For homes more than $484,350

 

FHA (96.5%)

 

3.5%

 

580

 

31%/43%

 

1.75%/0.85%

 

 

 

FHA (90%)

 

10%

 

500

 

31%/43%

 

1.75%/0.85%

 

 

 

FHA 203(k)

 

3.5%

 

640

 

31%/43%

 

0.85%

 

Buy plus rehab

 

VA

 

0%

 

620

 

41%

 

2.15% or 3.3%*

 

VA cert. of eligibility

 

USDA

 

0%

 

640

 

29%/41%

 

2%/0.50%

 

Rural areas only

 

HomeReady

 

3%

 

620

 

43%

 

1% or more

 

Low income only

 

Home Possible

 

3%

 

660

 

45%

 

0.75% or more

 

Low income only

* VA funding fee is 2.15% for first loan and 3.3% for subsequent loans.

Self-Employed Borrowers

If you’re a self-employed borrower, you might be asked to provide additional documents to show a consistent income and work history of at least two years. Some documents requested may include a profit/loss statement, a business license, your accountant’s signed statement, federal tax returns, balance sheets, and bank statements for previous years (the exact amount of time depends on the lender). Typically, self-employed borrowers need to produce at least the two most recent years' tax returns with all appropriate schedules.

Factors that go into approving a mortgage for a self-employed borrower, according to Fannie Mae, include the stability of the borrower’s income, the location and nature of the borrower’s business, the demand for the product or service offered by the business, the financial strength of the business, and the ability of the business to continue generating and distributing sufficient income to enable the borrower to make the payments on the mortgage.

If your situation makes it difficult to get a traditional mortgage, there are two options geared specifically for self-employed borrowers:

Stated income/stated asset mortgage

This type of mortgage is based on the income you report to the lender without formal verification. Stated income loans are sometimes also called low-documentation loans because lenders will verify the sources of your income rather than the actual amount. Be prepared to provide a list of your recent clients and any other sources of cash flow, such as income-producing investments. The bank may also want you to submit an IRS Form 4506 or 8821. Form 4506 is used to request a copy of your tax return directly from the IRS, preventing you from submitting falsified returns to the lender, and costs $50 per return. But you may be able to request Form 4506-T for free. Form 8821 authorizes your lender to go to an IRS office and examine the forms you designate for the years you specify, free of charge.

No-documentation loan

In this type of loan, the lender will not seek to verify any of your income information, which may be a good option if your tax returns show a business loss or a very low profit. Because it is riskier for the bank to lend money to someone with an unverified income, expect your mortgage interest rate to be higher with either of these types of loans than with a full-documentation loan. Low- and no-documentation loans are called Alt-A mortgages, and they fall between prime and subprime loans in terms of interest rates.

Preapproval Decisions

After reviewing your mortgage application, a lender will usually give you one of three decisions: preapproved, denied outright, or preapproved with conditions. In the third scenario, you might need to provide extra documentation or lower your DTI ratio by paying down some credit accounts to satisfy the lender’s conditions. If you are denied outright, the lender should explain exactly why and provide you with resources on how to best tackle the problems.

In many cases, borrowers need to work on boosting their credit score and ironing out a spotty payment history. Once you know what you need to address, you can take the time and effort to improve your credit and financial health to get a better mortgage deal when you’re ready to embark on your home search. Doing so can save you significant money on mortgage pricing and ensure you get lower interest rates and terms when shopping for different lenders.

The Preapproval Letter

If you are preapproved, your lender will provide you with a preapproval letter on official letterhead. This official document indicates to sellers that you’re a serious buyer and verifies that you have the financial means to make good on an offer to purchase their home. Most sellers expect buyers to have a preapproval letter and will be more willing to negotiate with those who prove that they can obtain financing.

Preapproval letters typically include the purchase price, loan program, interest rate, loan amount, down payment amount, expiration date, and the property address. The letter is submitted with your offer; some sellers might also request to see your bank and asset statements.

Getting a preapproval doesn’t oblige you to borrow from a specific lender. When you’re ready to make an offer, you can choose the lender that offers you the best rate and terms for your needs. Nor does getting a preapproval guarantee that a lender will approve you for a mortgage, especially if your financial, employment, and income status change during the time between preapproval and underwriting.

The Bottom Line

Go through the preapproval process with several lenders to shop interest rates and find the best deal. Again, you’ll want to shop mortgage lenders within 45 days, so all credit checks count as one hard inquiry, with minimum impact on your credit score. And if you’re just starting to think about homeownership, the preapproval process can help you get your credit and finances in better shape for when the time is right.

Remember that a mortgage preapproval doesn’t necessarily guarantee you a loan. Preapproval letters are conditional on your financial and employment information being truthful and consistent before your loan closes. Likewise, if you fail to disclose key information—a divorce, an IRS tax lien, or some other issue—and a loan underwriter finds out about it later, you can receive a denial for your loan.