Mortgage Pre-Approval: What Is It? Why Do I Need It?
09/10/2018 Jerrica Kowcheck
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Shopping for a new home is an incredibly exciting experience. But it also can be frustrating, confusing, and even a bit scary. Sometimes it seems there are more questions than answers. Where should you buy? How many bedrooms do you need? And most importantly—how much house fits your budget?
Enter pre-approval. A mortgage pre-approval is a document issued by a lender that shows sellers that you’re a serious buyer. It proves that your finances, employment, and other pertinent information have been evaluated and that you’ve been qualified for a loan up to a certain amount. In essence, it’s a seal of approval that the deal will go through as planned, should the seller accept your offer.
Pre-Approval vs. Pre-Qualification
Although many people use the terms pre-approved and pre-qualified interchangeably, there is a huge difference between the two.
Pre-Qualification means that you’ve spoken to a lender, given them some basic information on your financial situation, and obtained an estimate of how much you may be qualified to borrow. No guarantees are made—it’s simply a model of what your mortgage could look like, should you be approved.
Pre-Approval means that the loan is all but a done deal once your offer is accepted and you sign on the dotted line. Your lender examined your finances, calculated your debt-to-income (DTI) ratio, verified your employment, determined your creditworthiness, and matched you with the loan program that best fits your situation. Although there are a (very) few cases where a pre-approval can fall through after your offer is accepted, it is the best way to stand out from the crowd and position yourself first in line to purchase your dream home.
Why Pre-Approval Is Preferred Over Pre-Qualification
On the surface, it seems like pre-qualification should be enough. It’s simple. It’s easy. It tells the seller that you probably can afford the home, and that you’re serious enough to be on the short list of potential buyers.
However, it doesn’t provide a complete picture of your finances, but it does give you and the seller a snapshot of your borrowing abilities.
Put yourself in the seller’s shoes. One potential buyer says, “I love this house, and I’d like to buy it—as long as the bank gives me the green light.” Another says, “I’ll take it. Here’s my pre-approval or pre-qualification letter.”
Which buyer would you go with?
What Do I Need to Get Pre-Approved for a Mortgage?
The pre-approval process requires you to provide certain documentation. Although this can vary from lender to lender, most will want to see:
- At least 30 days of pay stubs for you and any co-borrower (such as a spouse)
- Bank statements dating back two months or more
- Tax returns from the past two calendar years
- Statements for any assets, such as stocks, bonds, 401Ks, IRAs, etc.
If you want “extra” income, such as alimony or child support, included in your income, your lender will need to see proof of that as well. (This requirement can generally be satisfied by providing a copy of the divorce decree granting the amounts listed.)
It’s common for parents or other family members to gift homebuyers with the down payment for the home. If this is the case, you’ll need a letter from the person providing the money attesting to the fact that it is, in fact, a gift with no expectation of repayment. Otherwise, the money might be counted as a loan, which increases your debt to income ratio and reduces the amount of mortgage you may qualify for.
If you’re self-employed, the process becomes a bit more complicated, although not insurmountable. You’ll probably be asked to prove your work history and show a consistent income for the past two years. Your lender may require extra documentation, such as a notarized statement from your accountant, profit-and-loss statements, business license, etc.
Although the pre-approval process can seem financially invasive, remember: You’ll have to fill out all this paperwork sooner or later to obtain a mortgage anyway. Better to get it out of the way and put yourself in a better buying position, so you can concentrate on finding your new home!
How Much Can I Be Pre-Approved For?
The amount of loan you qualify for depends on several things, including your income, DTI ratio, credit score, and your loan-to-value (LTV) ratio.
Your LTV ratio is calculated by dividing the loan amount by the home’s value. Generally speaking, the higher the ratio, the higher your interest rate. You can bring your LTV ratio down, however, by making a larger down payment.
If your LTV ratio is above the accepted limits by your lender, you may have to purchase private mortgage insurance (PMI), which gives lenders protection should you default. On a $200,000 loan with a 5% down payment, your PMI would be $130 a month.
There are circumstances where you may be pre-approved for more than the purchase price of the home, such as if it needs substantial repairs. If this is the case, speak to your lender about your ability to customize a mortgage.
How Long Does a Pre-Approval Typically Take?
Depending on your lender and the complexity of your application, the pre-approval process can take a few hours or a couple of days. Having all the documentation you need can speed the process along. The more prepared you are, the easier the process will go on the lender’s end.
Once the application process is over, you’ll receive a decision—approved, denied, or conditional.
- Approved: Congratulations! You are well on your path to homeownership and can expect your pre-approval letter within the next few days.
- Denied: The lender cannot grant you pre-approval at this time. There are a number of factors that can trigger a denial, including credit problems, insufficient income, or asking for too much money. Your lender can give you detailed information about why your application was denied, as well as provide concrete steps you can take to fix any issues. Don’t give up!
- Conditional: Something in your application sent up a few red flags, and the lender will be happy to grant you a pre-approval once those red flags are addressed. It could mean you need to supply additional documentation, boost your credit score a few points, prove you have the money necessary for a down payment, or decrease your DTI ratio to meet the lender’s criteria. Once the appropriate steps are taken, your pre-approval can proceed.
What Is a Home Loan Pre-Approval Letter?
Pre-approval documentation usually comes in the form of a “Pre-Approval Letter.” This document conveys your pertinent financial information for easy analysis by the seller and the seller’s agent. A pre-approval letter typically includes:
- Down payment amount
- Loan amount
- Purchase price
- Expiration date
- Government-backing program, if applicable (FHA, Fannie Mae, Freddie Mac, USDA, etc.)
What it doesn’t say (but that sellers pick up on, regardless) is how serious you are about buying their home, and your ability to financially make good on the deal. A mortgage pre-approval letter in hand is as good as a ticket to the front of the line in the homebuying queue!
The mortgage industry uses a lot of unfamiliar words and phrases. Find quick definitions and get clarity with our Mortgage Glossary.
How Long Is a Pre-Approval Letter Valid?
Like all good things (ice cream, fine steaks, and leftover lasagna), pre-approval letters have an expiration date—typically within 60 to 90 days, depending on the lender. At PennyMac, most pre-approvals are good for up to 120 days, although you will be able to renew your pre-approval twice if you are still looking for that perfect home.
There are a number of reasons for that cutoff. Your income could change significantly, making it impossible for you to afford the mortgage payment. You or your spouse could become unemployed. Your credit score could drop drastically, disqualifying you from the lender’s pre-approval criteria. You could open an additional line of credit, sending your DTI ratio through the roof.
Some lenders will extend your pre-approval letter if you ask, but be aware that they’ll probably take another look at your numbers to make sure you’re still eligible. Others will insist that you begin the process all over again from scratch, which is why you shouldn’t seek out a mortgage pre-approval until you’re sure you’re ready to buy soon.
When Should I Get Pre-Approved?
No one loves filling out mountains of paperwork – especially when they just completed that paperwork out two to three months ago. Begin a pre-approval too soon, and you’re back to square one if you don’t find your dream home in time. Begin it too late, and you miss out on that same dream home because someone got their pre-approval faster.
The timing can be tricky, but PennyMac has some advice.
- Start sooner if you’re self-employed or your income is commission-based. These pre-approvals likely will take longer based on the paperwork alone, so be sure to allow for the extra time.
- Start sooner if you’re looking to buy in a hot market. That pre-approval letter is going to be your golden ticket when the houses are snapped up in days, if not hours.
- Start as soon as you find the ideal home. Sometimes, the perfect home comes out of the blue; other times, you’ve been secretly coveting a home in your ideal neighborhood that suddenly goes on the market without warning.
- Start later if you’re on the fence about what you want. There’s no sense in getting pre-approved if you and your spouse still are debating neighborhoods, school zones, or the number of bathrooms your ideal home should have.
- Start later if you have some “cleaning up” to do—whether it’s your DTI ratio, credit score, or other factors that could result in a denial.
Not quite sure when to start? Reach out to PennyMac! Our team of loan officers can help you determine when to start the pre-approval process.
So, When Does Pre-Qualification Make Sense?
Mortgage pre-approval is the way to go the majority of the time. But in life there are no absolutes, and there are times when one might prefer pre-qualification over pre-approval:
- You’re just starting out. For a first-time homebuyer, the process can be frustrating and confusing. If you’ve never gone through the mortgage process before, pre-qualification can help you ease into things.
- You’re just shopping around. A pre-qualification serves as a dry run to a pre-approval. For newcomers, this less-invasive process may be more attractive than the no-holds-barred, everything-out pre-approval method.
- Your finances are “iffy.” While a pre-qualification can’t tell you exactly what you may (or may not) be approved for, it can give you an estimate—and if you’re unsure about the current state of your finances, an estimate is better than nothing.
- You’re in a hurry. While pre-approval can take hours or days, pre-qualification can often be done in a matter of minutes. It may not seal the deal for your seller, but in a hot market, showing up to an open house with a pre-qualification letter is better than showing up empty-handed.
Advantages of Pre-Qualification
Pre-qualifying (like pre-approval) is optional. You don’t necessarily have to do either to purchase a home, but it makes it far easier if you take the additional steps.
Understanding what you’re getting into is important. A pre-qualification can show you what loan programs you may qualify for, as well as what your target price range should be. And if you’re not quite ready to get pre-approved, it’s the next smartest step you can take.
Pre-qualifying for a mortgage allows a lender to take a look at your finances— including your credit score. Your lender will go off of the information provided in your credit report and give you a realistic picture of what you can expect, should you decide to seek pre-approval.
Getting pre-qualified comes with some perks, including:
- Saving time. Because you have an estimate of what you may be able to borrow, you won’t need to waste time looking at homes outside your price range.
- Bidding confidently. Once you know your borrowing threshold, you’ll be better able to bid inside your comfort zone because you know you’ll (probably) be approved for that amount.
- Streamlined closing. You may not have gone through the entire application process, but pre-qualifying gives you a head start on the paperwork you’ll eventually need to fill out. It also establishes a relationship with your lender, who is better primed to provide you with their considerable knowledge and advice.
Want to dive deeper into mortgages? Check out our full series of articles to further your understanding of the home loan process.
|1) Getting Prepped||4) Loan Underwriting|
|2) The Application||5) The Closing|
|3) Loan Processing||6) Loan Servicing|
Pre-Approval: The Bottom Line
Homebuying can seem like a competitive sport. Who can get to the finish line first? Who has the biggest advantage? Who will ultimately triumph? Pre-approval provides you the upper hand at every stage, allowing you to secure your dream home.
If you’re not ready to take part in the full pre-approval process quite yet, pre-qualification still is a useful pre-game strategy providing you with the roadmap you need to reach the finish line at your own pace.
How Do I Get Pre-Approved or Pre-Qualified?
Getting started with a mortgage is simple with PennyMac’s BuyerAdvantage Pre-Approval or a pre-qualification. The first step is credit and income verification, which is how we can help you determine how much you’re able to afford and give you a monthly payment estimate.
You’ll need to start by calling a licensed loan officer or using our mortgage access center (m.a.c) to fill out your application online. The benefit to applying online is you can log back in at anytime to complete your app or fill in missing information. Easy, 24/7 access with any device makes the loan experience less complicated and you can check the status of your loan from anywhere!