Editor’s Note: This story originally appeared on Dot2.
Being pre-approved for a mortgage allows you to create an accurate budget while also putting you in a stronger position when you make an offer on your dream home. But what exactly is mortgage pre-approval and how does it work? Here’s everything you need to know.
What is mortgage pre-approval?
In its simplest form, a mortgage pre-approval is an agreement between you and a lender. It indicates that they are willing to provide you with a mortgage and defines the amount they will lend you. In addition to the amount, it also details other terms, such as the interest rate offered.
This deal depends on your current financial situation and you will need to submit various documents for inspection. Usually, a mortgage pre-approval is valid for 45 to 90 days.
Pre-approval versus pre-qualification
Another term you may have heard is mortgage prequalification. Prequalification is a much less rigorous process that gives you an idea of how much a lender is willing to lend you, but with no strings attached.
There is no guarantee that the lender will accept the loan if you proceed with the purchase of a house. They will need to take a closer look at your finances before making a decision. During this time, if you are pre-approved by a lender, they will make you an offer that guarantees that you can take out the loan on a home.
Pre-qualifying gives you a rough idea of the price of the home you can afford. Pre-approval, on the other hand, is worth getting when you know you’re seriously considering buying one.
How to get pre-approved for a mortgage
To become pre-approved, you will need to visit the lender of your choice. You will need to complete a mortgage application form and provide the following documents.
Proof of income and employment
Your lender will require you to provide at least three months of recent pay stubs and ideally two years of W-2 statements (in the US) or Notice of Assessment from the Canada Revenue Agency (in Canada) . This shows them how much your regular income is and proves that you are currently employed or self-employed.
The lender may contact your workplace to verify your employment. If you recently started a new job, you will also need to provide contact information for your former place of work.
Your credit score will primarily be used to calculate the interest rate you can expect to pay. A score of 740 or higher will generally qualify for the best rates.
Proof of Assets
By providing bank statements, your lender will be able to see that you have the funds for a down payment and closing costs in savings. You will also need to show that you have reserves to cover unforeseen expenses and emergencies.
Documents and additional documents
You will need to provide your ID, a driver’s license is acceptable, and your US social security number. Please note that Canadian applicants are not required to provide their SIN (Social Insurance Number). In addition, you will need to sign a form allowing the lender to perform a credit check.
What happens next?
It usually takes between three and 10 days for the lender to approve or reject your application. If you have been accepted, they will inform you of the following:
- How much loan you are entitled to
- The likely interest rate
- An estimate of your future mortgage payments
- Various other features and conditions of your loan
The pre-approval letter can be used when you make an offer on a house. This proves to the seller that you have the financial backing for your offer, a great advantage in a hot market.
How to improve your chances of getting pre-approved
Before applying for pre-approval, it helps to understand how the lender will arrive at their decision. There are a few important things that will interest them the most.
DTI (debt to income) ratio
The lower your debt ratio, the more attractive you are to a lender. Most lenders will accept the 43% maximum, but it’s worth lowering that number as much as possible. So, for best results, pay off as much debt as possible to reduce your DTI.
High credit score
A good credit score will always work in your favor, and it’s worth doing everything you can to improve it before you start the process of buying a new home. Lenders will be interested in how much credit you are actively using — credit utilization. Maintaining a consistent 30% credit utilization is a great way to boost your credit score.
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