Getting a pre-approval for a mortgage is the first step in the home loan process.Before you can start looking at homes with a real estate agent you will need a mortgage pre-approval letter. A pre-approval means a mortgage lender has pulled your credit report, verified your income using W2’s, tax returns, or bank statements. A mortgage pre-approval letter shows that your chances of getting approved for a mortgage for high.
Pre-qualified vs. Pre-approved
Some terms even sound very familiar when in fact they’re very different and two of these terms are “pre-qualified” and “pre-approved”. They sound very similar but they are not. The primary difference is the degree of validation. Let’s take a closer look at the two and why getting pre-approved is important as you begin your home shopping journey.
What is a Mortgage Pre-Qualification?
A mortgage pre-qualification is a good idea about how much you might qualify for should you submit a loan application to a mortgage lender. The loan officer will not ask for any documents to verify the statements made. Which makes a mortgage pre-qualification letter not sufficient for any real estate agent, or seller for that matter. Most lenders will need to check your credit score before issuing a pre-qualified letter, but that’s about the only thing they verify. Finally, you’ll need to let the loan officer know how much cash you have available for a down payment, income to check your debt-to-income ratio, and a general idea of the type of mortgage rate you will receive.
What is a Mortgage Pre-Approval?
A mortgage loan pre-approval lets everyone involved know that you’re serious about buying a home. That includes your agent, the sellers and the seller’s agent. Typically a loan officer will have you complete a mortgage application to start the process. A pre-qualification is a conversation with a loan officer or mortgage broker. A mortgage approval is more in-depth. Consider for example a seller is looking at two separate offers. One has a pre-approved letter attached and one does not. Which do you think the seller will accept? Most importantly you will know which price range you can afford. The maximum monthly payment and loan amount you’re approved for depends your debt-to-income ratio.
The Mortgage Pre-Approval Process
A pre-approval puts in you in a stage where all you need to do is find a property. For a pre approval, you’ll submit a loan application and provide the necessary documentation required by the loan officer. Here is what you can expect to provide:
Documents Needed for a Mortgage Pre-Approval
- Last few pay stubs
- Past 2 years of W’2
- Past 2 years of Tax returns
- 2-3 months of bank statements where downpayment is coming from
- The lender will need to check credit
A pre-approval letter provides the necessary third-party verification that what you told your loan officer is documented.
You’ll be asked to provide your most recent pay check stubs covering a 30 day period as well as your two most recent W2 forms. Lenders will ask that you have at least two years of employment and your two W2 forms will document this requirement. Your pay check stubs will also show a year-to-date amount which should coincide with your regular pay. Get a Pre-approval letter from a lender now Part time income Part time income can be used as well as long as you can show there is at least a two year history of part time employment and the lender can make a reasonable determination the part time income will continue into the future. A common situation where part time income is used is in the case of a substitute teacher, for example.
If you’re self-employed or get additional income outside of your job and you want to use that other income to help get your pre-approval, you’ll provide your two most recent federal income tax returns both personal and business. In addition, you can expect to provide a profit and loss statement for the current year. Most often this P&L can be compiled by you but sometimes a lender will request the P&L be completed and certified by a CPA.
When lenders look at your returns they want to see consistency from year to year. They will average your annual net income to arrive at a median yearly income that will be used. For example, year one you made $90,000 and year two $95,000. The qualifying amount will be $90,000 + $95,000= $185,000 divided by 2= $92,500 average yearly income.
Credit Score Requirements
Lenders will request a credit report and credit scores from each of the three main credit bureau, Equifax, Experian and TransUnion. The scores will range from 350 to 850. Typically, a borrower must have a credit score of at least 580 to qualify for an FHA mortgage.
Credit Score Ranges
- 720+ = Excellent Credit
- 680-719 = Good Credit
- 620-679 = Fair Credit
- 580-619 = Poor Credit
- 579 or under = Bad Credit
Cash to Close
Your lender will also need to verify sufficient funds to close on a purchase. This includes not simply enough for a down payment but for the associated closing costs as well. Lenders also want to see some funds available after you close which lenders refer to as “cash reserves.” The reserve amount can vary based upon the type of loan being applied for or a particular lender’s own internal guidelines.
The Final Pre-approval
After you’ve supplied your loan officer with the above documentation the loan officer will then provide you with your loan pre-approval letter with the lender’s letterhead. This letter won’t show how much you’re pre-approved for but that you are pre-approved and all you need is a property address. The letter will also show what the loan officer reviewed prior to issuing the letter. The letter will state something such as, “This pre-approval has been issued after review of a credit report and credit scores, verified income and sufficient cash on hand to close” or some such wording.
Being pre-approved for a mortgage is necessary
In today’s marketplace, sellers expect to see a pre-approval letter. That’s much different than it was a few years ago when a pre-approval letter was nice but not necessarily a seller requirement, because almost anyone could get approved for a loan. A pre-approval letter is your own peace of mind. You can now shop with confidence.