How to get pre-approved for a mortgage

If you're house hunting, it's important to know the difference between mortgage prequalification and preapproval.

Mortgage prequalification lets a lender tell you how much money you could qualify to receive. When a lender preapproves your credit, they make a conditional agreement to offer you a set mortgage amount. A preapproval, on the other hand, can save you a lot of time and heartache during the mortgage process. In the event of multiple offers on a home, buyers with preapproval are more likely to win over a buyer who has no financial backing.

If you’re ready to commit to the homebuying process, then you should follow these steps before submitting a loan application.

How to get pre-approved for a mortgage in 5 steps

Getting preapproved for a mortgage loan isn’t difficult if you do a little preparation beforehand. Follow these steps to ready yourself for the preapproval process:

1. Know your credit score
2. Understand your debt to income ratio
3. Gather essential documents for the preapproval process
4. Research your lending options with multiple mortgage lenders
5. Take charge of your finances to avoid setbacks

1. Know your credit score

Before submitting any paperwork or touring homes, get a copy of your credit score — as credit checks during the mortgage application process are inevitable. There are several ways to access your credit history, including paying one of the three major credit bureaus for access. Alternatively, major credit card companies like American Express, Discover, and Capital One offer a free credit score updated once per month.

The credit score you need will depend on the type of loan you’re looking to obtain.

• For an FHA loan, you’ll need a score of at least 580 with a down payment of 10 percent or more
• VA, USDA, and conventional loans require a score of at least 620

A good credit score can help you qualify for lower interest rates. If your credit is in good shape, then check out Credible to determine what kind of mortgage rates you'd qualify for today.

5 FACTORS THAT AFFECT YOUR CREDIT SCORE

2. Understand your debt-to-income ratio

Although other factors affect your credit score, one of the most important things that will determine how much, if any, money a lender is willing to give you is your debt-to-income ratio (DTI). You can calculate your debt-to-income ratio by dividing your debt payments by your gross income.

Debts your credit score considers include:

• Loans (car, personal, student, mortgage)
• Revolving debt (credit cards)

You may have other obligations that don’t show up on your credit report like:

• monthly payments towards a medical bill
• rent-to-own payments
• personal debt to a family member or friend.

Lenders may not look at debt payments that don’t appear on your credit report; however, you should consider adding them to your equation to determine if you feel comfortable taking on additional debt.

For example, let’s look at a potential borrower with a $5,000 per month income after taxes. They have the following debts:

• Personal loan: $200 per month
• Car loan 1: $400 per month
• Car loan 2: $300 per month
• Student loan: $400 per month
• Credit card: $200 per month. Total monthly debt payments: $1500 per month
• Total monthly debt payments: $1500 per month

This borrower has a DTI of 30 percent. That means 30 percent of their income goes towards debt payments. When looking at approving a loan, lenders also factor in the potential mortgage payment for the DTI ratio. So, if this borrower had a mortgage payment of $1,200 per month, their DTI would increase to 54 percent.

The Consumer Financial Protection Bureau notes that most lenders only allow a maximum of a 43 percent DTI, though lenders prefer to see a number closer to 30 percent or lower. You can estimate how much a mortgage loan will affect your DTI by using an online savings calculator.

CALCULATE YOUR DEBT-TO-INCOME RATIO AND FIND OUT WHERE YOU STAND

3. Gather documents for preapproval process

Once you’ve reviewed your credit score and debt-to-income ratio, begin putting your paperwork together. Set up a digital folder on your computer or keep a paper folder in a safe place. You’ll want to have the following documents on hand:

• Tax documents from the past two years
• Pay stubs or W2s for proof of income
• Any 1099s or other materials for miscellaneous or self-employment income
• A letter documenting any monetary gifts you received to help with your down payment
• Asset information (cars, other properties, retirement, IRA, investment accounts)
• Debt information (credit card, personal loans, etc.)
• Any information about child support or other legal obligations
• Proof of the rent you’ve already been paying
• Your lender will also pull your credit report to verify and update any information

When you use an online mortgage broker like Credible, you can get personalized rates and pre-approval letters without a hard inquiry that could negatively affect your credit score.

HOW TO FIND THE BEST MORTGAGE RATES AND FASTEST CLOSINGS

4. Research your lending options from multiple mortgage lenders

Now it’s time to research different lender options. Check out the interest rates and APRs. When you’re researching these, remember:

• An APR, or annual percentage rate, is the interest rate on your loan stated as a yearly number. The APR may include fees as well.
• The difference of 1 percent in your interest rate could save you thousands of dollars over the life of your loan.

Ask your lenders about fees they charge with your loan. Typical fees lenders charge for mortgage loans include origination fees, closing costs, title fees, PMI, taxes, and other miscellaneous charges. Your loan origination fee will likely be the most expensive. Most origination fees are about 1 percent of the loan ($2,000 on a $200,000 loan).

You can apply with multiple lenders at once if you want to get a more accurate interest rate. If you apply to multiple lenders within a few weeks, they are lumped together for minimum impact on your credit score. Use an online comparison website like Credible to get rates from several lenders at once.

THIS MORTGAGE RATE MISTAKE COULD COST YOU THOUSANDS

Don’t be afraid to ask questions. Questions you’ll want to consider include:

• How much do I need for a down payment on this loan? Supplying a down payment of at least 20 percent can reduce fees, lower your interest rate, and eliminate the need for a PMI.
• How much are the loan origination fees?
• Are the miscellaneous fees (application fees, etc.) negotiable? Some lenders include "junk" fees like application fees and filing charges. You may be able to have these removed if you ask.
• Would purchasing discount points benefit me? How much do you charge for discount points? While discount points can be helpful for some borrowers, you’ll want to run some numbers to determine if you’ll benefit.
• Do you offer fixed-rate or variable-rate mortgages? If you need a stable monthly payment, a fixed rate offers you the best benefit.
• Can you approve loans in-house, or will we need to work with a third-party?

5. Take charge of your finances to avoid setbacks

Once you are ready to apply for a home loan, put your credit cards away and don’t use them again until you have the keys to your new home in hand. Buyers can (and have) lost a preapproval buying furniture for their new home on credit.

You’ll also want to avoid switching jobs, opening new lines of credit, making late payments, or changing bank accounts. Try to keep your financial transactions as simple as possible, so your lender doesn’t have a reason to back out of the preapproval.

Most homebuyers can prequalify for a loan in a few minutes or hours. If you want preapproval, expect it to take at least a few days. If your credit is less than perfect, it can take even longer. You can find out if you qualify for a quick preapproval letter in less than three minutes by using Credible to compare rates from multiple lenders.