Mortgage loan preapproval: What it is & how it helps you
Before the exciting process of house hunting can get underway, prospective homebuyers must be preapproved for a mortgage.
Preapproval provides a clear picture of what a borrower can afford and acts as a starting point to begin narrowing down affordable home buying options.
The process provides a conditional agreement that your mortgage application may be granted by a lender and that you are able to qualify for financing. As an official status of eligibility, preapproval encourages sellers to move forward with an offer, given the added assurance that a prospective buyer’s loan will be secured.
When should you get preapproved for a mortgage?
It’s best to get preapproved before you even start shopping for a home. Many first-time buyers pick out an ideal home before meeting with a lender. All too often, this oversight leads to unexpected issues, such as a limited borrowing capacity, that cause the sale to fall through.
By seeking preapproval before landing on a home, these adverse issues can be uncovered and potentially resolved before the mortgage process begins to move forward. With the knowledge of how much you’ll be able to borrow, you can explore buying options with the certainty that the property is in your price range.
Purchasing real estate can be a complicated process, requiring realistic expectations and a thorough understanding of the many factors that go into buying a home. For this reason, it is always best to begin the mortgage process with the help of a loan officer.
Does preapproval guarantee a mortgage?
Preapproval does not guarantee a mortgage will be approved. It does, however, involve a thorough review of your financial background and sets realistic parameters around how much you can afford to borrow if your application is approved.
Although it doesn’t lock in your mortgage approval, a letter of preapproval is still an important step in the early homebuying process. Having this official documentation from a lender can help motivate sellers in a crowded housing market, giving you a strong advantage when competing with other buyers. Preapproval also encourages real estate agents to take you on as a client, as it indicates you are serious and motivated about buying a home.
Preapproval is not a guarantee, but it is also not a commitment. Just as lenders reserve the right to reject your application, you’ll still be able to back away from the mortgage process without consequence.
How to get mortgage preapproval
The preapproval process involves a thorough examination of a potential borrower’s financial situation to determine their price range and mortgage loan options.
A borrower’s credit score, debt-to-income (DTI) ratio and employment history are among the many facets verified by your lender in this stage. While this information may have been provided by the lender during prequalification, preapproval is where this documentation is verified and deemed factual.
One of the first details your lender will review is your credit score. This three digit number provides a snapshot of your financial past and history of managing debt. Your credit score also reflects any delinquent payment patterns or missed payments in the past.
In order to be preapproved, your score will have to fall within a specific range. Let’s take a look at some of the common credit score ranges and what they mean for mortgage preapproval.
<580 = Poor
If your credit score falls below 580, you will be considered a heavy risk to lenders and won’t be likely to secure a mortgage.
580-669 = Fair
A credit score in this range might get you preapproved. While the borrowing options might be narrow, some lenders might offer a mortgage with some added requirements, such as private mortgage insurance.
>670 = Good
For most lenders, a score of 670 or above is considered “good,” and you will have an easier time getting preapproved. A score in this range won’t guarantee an approved application, but lenders will tend to be more open to financing a loan for a borrower in this range or above.
Lenders will use your debt-to-income ratio to decide if your financial situation can afford the added expense of a mortgage loan. DTI is calculated by taking the total of the borrower’s monthly debt payments, divided by their gross monthly income.
Debt obligations like student loans or car payments limit how much you’ll be able to afford for a mortgage loan. An ideal debt-to-income ratio can vary from lender to lender, but equal to or less than 35% is usually considered an acceptable threshold. Less than 20% is considered excellent, while DTIs greater than 45% are typically the maximum percentage for preapproval.
Your current means of income is a highly important factor for lenders. How long you’ve worked, what jobs you’ve had in the past and your current income will all influence your preapproval status.
Typically, lenders will look for two consistent years of steady employment in order to issue a letter of preapproval.
Difference between preapproval & prequalification
Mortgage preapproval status is determined after the borrower has prequalified for a loan. Prequalification describes the lender’s ability to grant a loan based on the documentation submitted by the borrower. This documentation typically details the borrower’s financial status and is used to gauge the terms of the mortgage and what options the borrower can afford.
Prequalification provides all parties with an assurance that if a loan process moves forward, the borrower is creditworthy and can pay back the loan. While prequalification indicates that the loan process can continue, it does not provide definitive assurance that a loan will be preapproved. Preapproval can only be granted once the documentation submitted during prequalification is verified.
Loan officers will then confirm the details provided during prequalification, such as employment verification, credit history and proof of assets, to determine preapproval status.
Benefits of Preapproval
As an essential step in the homebuying process, preapproval holds an array of benefits for buyers and sellers alike:
- Knowing your buying power
- Reduces mortgage timelines
- Appealing to sellers
Knowing your buying power
Prospective buyers sometimes make the mistake of researching home options prior to getting preapproval. With their heart set on a new property, these buyers will then file for a mortgage application, only to discover unexpected hurdles down the line that prevent the sale from going through. Meeting with a loan officer as the first step in the mortgage process and getting a letter of preapproval will ensure that a borrower can explore home options with confidence and avoid costly and disappointing setbacks that could hinder a sale.
Reduces mortgage timelines
Another benefit of obtaining preapproval is that it can reduce the amount of time it takes to close on a sale. It can be a great negotiating tool when competing with other buyers in the market and helps avoid unnecessary issues that could pop up along the way.
Sellers will always be wary of buyers without a lender’s backing, so a letter of preapproval can help your offer stand out.
Appealing to sellers
Selling a home, as well as buying one, can be a demanding endeavor. When moving forward with a proposal, sellers risk missing out on a better or timelier offer should the buyer’s loan fall through.
Starting over with a new buyer is a time-consuming and costly hurdle that home sellers and their real estate agents will always seek to avoid. A letter of preapproval indicates to sellers that a potential buyer is committed to buying a home and is motivated to complete the sale. The added assurance from a qualified lender shows that adverse events are unlikely, and the transaction can be expected to conclude free of unexpected hurdles.
Limitations of Preapproval
Preapproval may provide a good idea of what a borrower and lender can expect during the homebuying process, but it is far from a guarantee that the sale will move forward without interruption. They are not meant to act as the final word of approval when applying for a mortgage.
Letters of preapproval are often conditional and based on the borrower’s current financial standing. If a borrower was laid off from work, for example, their financial situation would no longer suit the terms of the previous agreement and their preapproval status could be revoked.
Additional fees such as appraisal costs and homeowner’s insurance might not be factored in to the preapproval’s estimate. Borrowers should continue to assess their own finances and plan for possible future expenses even after getting preapproved.
Preapproval allows prospective buyers to search for a home with an accurate estimate that they can afford. This reassurance not only helps home buyers shop with confidence, but will also go a long way in avoiding potential interruptions to the sale down the line.
It is always best to begin the home buying process with the help of a trusted lender who can guide the loan’s progression from preapproval to closing.