Obtaining Mortgage Preapproval: A Crucial Step in Homebuying- Step 5

Securing Your Dream Home: The Importance of Mortgage Preapproval

After an extensive period of exploring online listings and attending numerous home tours, you've stumbled upon your dream house. The ideal location, perfect layout—this is the one. However, before diving into making an offer, a crucial step awaits: obtaining preapproval for a mortgage loan, a distinct process from prequalification, which you might have already undergone.

Preapproval vs. Prequalification:

Preapproval serves as a bank's commitment to your loan. In this phase, the mortgage lender scrutinizes your income, conducts a credit check, and specifies the amount you can borrow for your home loan. This preapproval closely resembles an actual mortgage, typically valid for about 90 days—making it essential to secure just before submitting an offer.

On the other hand, prequalification is a more preliminary estimate. It doesn't involve a credit check, and proof of income isn't required. Prequalification often occurs at the outset of the homebuying journey when deciding whether to proceed. It's an exploratory phase, answering questions like: Can I qualify? How much could I potentially borrow? What might my interest rate be? Prequalification allows you to explore multiple loan providers, aiding you in comparing terms.

Once prequalified, you gain insights into your preferred mortgage lender. Moving forward, you'll seek preapproval from the chosen lender—typically the one finalizing your loan. While you can stick with this lender, the process offers flexibility, allowing you to evaluate competing offers before locking in your loan. Understanding these stages ensures you're well-prepared for a smoother path toward homeownership.

Preparing for Preapproval: Essential Documentation

The preapproval process closely mirrors the final loan approval, necessitating a comprehensive overview of your financial history for the preceding two years. Gathering the required documents in advance can streamline the preapproval process, making it more manageable. Here's a basic checklist of what you may need:

Information for the federally mandated mortgage application:

Full name, date of birth, social security number, and phone number
Number of children (if any) and their ages
Marital status
Residential history for the past two years, including landlord details and monthly rent for renters, and mortgage, tax, and insurance information for homeowners
Two years of employment history: companies, addresses, titles held, and contacts
Two years of income, covering bonuses, commissions, and self-employment
Account balances for all checking, savings, retirement, and investment accounts
Current fixed debt details, encompassing credit cards, mortgages, car payments, alimony, child support, and student debt
Documentation for any bankruptcies within the last seven years, ongoing lawsuits, and properties where you act as a cosigner
Clarification on whether a portion of the down payment will be borrowed

This thorough preparation ensures a smoother preapproval process, allowing you to present a comprehensive financial profile to your mortgage lender.

Essential Loan Application Documentation:

Written authorization for the lender to conduct a credit check.
Written explanations for any derogatory items in the credit report.
Discharge papers from any bankruptcy within the last seven years.
For renters, either 12 months of canceled rent checks or a confirmation form from the landlord verifying on-time rent payments.
For landlords, all relevant lease agreements and bank statements.
Confirmation of the listing agreement if selling a home while purchasing.
30 days of pay stubs.
Two years of W2 forms.
Two years of personal federal tax returns.
If self-employed, two years of business tax returns.
Year-to-date profit and loss statement for the self-employed.
Divorce decree (if applicable) and documentation of child support and alimony payments.
Two months of bank statements from checking, savings, retirement, and investment accounts.
If receiving gift funds, a statement from the giver confirming it is a gift and not a loan.

While it's possible to submit an offer without a preapproval letter, including this letter with your offer demonstrates to the seller that you're a committed buyer with secured financing, potentially providing an advantage, especially in competitive markets. Furthermore, obtaining preapproval provides insights into your down payment, monthly mortgage payments, and loan terms, offering a clear understanding of your financial capabilities.

Although a hard credit check is performed for preapproval, resulting in a slight impact on your credit, the benefits often outweigh the temporary dip. While it's advisable to have a high credit score before applying for a mortgage, the advantages of preapproval generally surpass the potential and brief reduction in your credit score.

Before seeking preapproval, it's crucial to be aware of your credit score (FICO score), which typically ranges from 300 to 850. Obtain your credit report from annualcreditreport.com, ensuring there's no suspicious activity that needs resolution. Note that while this report details your credit history, it doesn't provide your credit score. You can obtain your score through your bank, credit card company, loan statement, credit score service, or by consulting a non-profit credit counselor.

Given that different consumer reporting companies (Experian, TransUnion, and Equifax) calculate scores differently, you may have multiple credit scores. Once you know your score, interpret it as follows:

Excellent credit (720 or above): Qualify easily for various mortgages with favorable interest rates and low fees.
Good credit (680-719): Likely qualify for a mortgage with a decent interest rate and standard fees.
Fair credit (620-679): May qualify, but options could be limited with higher interest rates and fees.
Poor credit (580-619): Qualification may be challenging, with limited options and higher interest rates and fees.
Bad credit (350-579): Generally difficult to qualify for a mortgage, though some exceptions may exist.

How to Identify a Mortgage Lender

Mortgage lenders come in various types, each with distinct characteristics. Direct lenders, such as banks and credit unions, are the most prevalent and interact directly with homebuyers. When dealing with direct lenders, you typically collaborate with a single loan officer throughout the entire homebuying process.

Another category of lenders is mortgage brokers, who act as intermediaries between you and a lender. While mortgage brokers charge a small fee for their services, initially covered by the lender, the cost is eventually passed on to you through the loan. The advantage of working with a mortgage broker lies in their ability to negotiate the best loan terms by partnering with multiple loan providers.

For those facing challenges in securing a traditional mortgage, hard money lenders may be an alternative, although it carries certain risks. Hard money lenders are private investors prioritizing property value over your ability to repay the loan, making them less concerned about your credit score or income. However, they often demand repayment within a relatively short period, ranging from one to five years, and their fees can be substantial.

If you find yourself uncertain about the type of lender or where to start looking, seek guidance from your real estate agent. With their experience, agents have likely collaborated with various loan providers and can offer valuable recommendations. Your agent can also assist you through the preapproval process, providing answers to your queries along the way.