What is mortgage prequalification?
Prequalification is an excellent first step for prospective homebuyers who may be uncertain whether their financial situation is suitable for a mortgage.
By providing information such as income, credit history and ongoing debts, borrowers receive valuable feedback on whether a mortgage loan is likely to be approved.
Prequalification will establish how big of a loan can be borrowed should the borrower move forward with the mortgage application. This process does not guarantee a loan will be approved but acts as a great starting place to establish financial needs and set expectations.
During prequalification, the borrower will provide documentation that lays out their financial status. This information is submitted by the prospective borrower and is not verified by the lender until a later stage. This gives the lender an overview of the borrower’s finances and helps determine if a mortgage loan is possible.
One of the key aspects lenders will look at during prequalification is the borrower’s debt to income ratio, which assesses whether the borrower’s income is enough to cover monthly mortgage payments.
Debt to income ratio
Debt to income ratio is a variable used by lenders to determine if a borrower’s financial situation can afford the added expense of a mortgage loan. It is calculated by taking the total of the borrower’s monthly debt payments, divided by their gross monthly income.
Other debt obligations, such as student loans or car payments, will limit how much a borrower can 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 a debt to income ratio of greater than 45% is typically the maximum percentage for prequalification.
Prequalification vs Preapproval
Following prequalification, preapproval is another initial step in building a mortgage loan.
Prequalification indicates that a borrow may be approved for a loan, but it does not give a definitive answer as to whether the loan will be approved. Preapproval, on the other hand, takes a much more in-depth look at an individual’s finances and helps lenders determine how much loan the borrower can handle.
While the borrower’s credit score, employment history and current debts are all provided to the lender during prequalification, these submissions are not verified by the lender until preapproval.
When prospective homebuyers take the first step to securing a mortgage, prequalification provides an excellent place to start.
By analyzing a borrower’s current financial situation and calculating their debt to income ratio, prequalification helps set manageable loan expectations and gives buyers the information they need to start shopping for a new home.