Home shopping often starts in a lender's office with a mortgage application and not at an open house. Most sellers expect buyers to obtain pre-approval for financing and are commonly willing to negotiate with those who prove that they can obtain a loan.
Key Takeaways
- A home seller often asks for a mortgage pre-approval letter before negotiating with a buyer.
- Pre-approval requires proof of employment, assets, income tax returns, and a qualifying credit score.
- Mortgage pre-approval letters are typically valid for 60 to 90 days.
- Upon pre-approval, the lender will provide the maximum loan amount, which helps set a price range for the home shopper.
Pre-Qualification vs. Pre-Approval
A mortgage pre-qualification can be useful as an estimate of how much someone can afford to spend on a home, but a pre-approval, often valid for 60 to 90 days, is more valuable. It means the lender has checked the buyer's credit, verified assets, and confirmed employment to approve a specific loan amount.
Buyers benefit by consulting with a lender, obtaining a pre-approval letter, and discussing loan options and budgeting. The lender will provide the maximum loan amount, which will help set the price range for the home shopper. Amortgage calculatorcan help buyers estimate costs.
Requirements for Pre-Approval
Mortgage pre-approval requires a buyer to complete a mortgage application and provide proof of assets, confirmation of income, good credit, employment verification, and important documentation.
Pre-approval is based on the buyer's FICO credit score, debt-to-income ratio (DTI), and other factors, depending on the type of loan.
Except for jumbo loans, all loans conform to Fannie Mae and Freddie Mac guidelines. Some loans are designed for low- to moderate-income homebuyers or first-time buyers. Others such as Veterans Affairs (VA) loans, which require no money down, are for U.S. veterans and service members.
Important
Upfront fees on Fannie Mae and Freddie Mac home loans changed in May 2023. Fees were increased for homebuyers with higher credit scores, such as 740 or higher, while they were decreased for homebuyers with lower credit scores, such as those below 640. Another change: Your down payment will influence what your fee is. The higher your down payment, the lower your fees, though it will still depend on your credit score. Fannie Mae provides the Loan-Level Price Adjustments on its website.
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1. Proof of Income
Potential homebuyers must provide W-2 wage statements and tax returns from the past two years, current pay stubs that show income and year-to-date income, and proof of additional income sources such as alimony or bonuses.
2. Proof of Assets
A borrower's bank and investment account statements prove that they have funds for a required down payment, closing costs, and cash reserves. The down payment, expressed as a percentage of the selling price, varies by loan type. Many loans require the buyer to purchase private mortgage insurance (PMI) if they are not putting down at least 20% of the purchase price.
3. Good Credit
Most lenders require a FICO score of 620 or higher to approve a conventional loan or 580 for a Federal Housing Administrationloan. Lenders typically reserve the lowest interest rates for customers with a credit score of 760 or higher.
The chart below shows a monthly principal and interest payment on a 30-year fixed interest rate mortgage based on a range of FICO scores for three common loan amounts. An interest rate tool from the Consumer Financial Protection Bureau lets buyers see how credit score, loan type, home price, and down payment amount can affect the interest rate.
On a $250,000 loan, an individual with a FICO score in the lowest (620–639) range would pay $1,288 per month, while a homeowner in the highest (760–850) range would pay just $1,062, a difference of $2,712 per year.
FICO Score Range | 620-639 | 640-659 | 660-679 | 680-699 | 700-759 | 760-850 |
Interest Rate | 4.656% | 4.100% | 3.670% | 3.456% | 3.279% | 3.057% |
$350,000 loan | $1,804 | $1,691 | $1,605 | $1,563 | $1,529 | $1,486 |
$250,000 loan | $1,288 | $1,208 | $1,146 | $1,116 | $1,092 | $1,062 |
$150,000 loan | $773 | $725 | $688 | $670 | $655 | $637 |
Since interest rates change often, use this FICO Loan Savings Calculator to double-check scores and rates.
4. Employment Verification
Lenders not only verify employment through a buyer's pay stubs but will likely call the employer to confirm a borrower's employment and salary.
Self-employed buyers provide additional information such as the stability of the borrower’s income, the location and nature of the business, the financial strength of the business, and the ability of the business to continue generating and distributing sufficient income to enable the borrower to make the payments on the mortgage.
5. Other Documentation
Personal documents and identification required for pre-approval include the borrower's driver's license, Social Security number,and authorization to allow the lender to pull a credit report.
Pre-Approval vs. Approval
A lender is required to provide a document called aloan estimatewithin three business days of receiving a completed mortgage application. It outlines the pre-approved loan amount and maximum loan amount, terms and type of mortgage, interest rate, estimated interest and payments, estimated closing costs, an estimate of property taxes, and homeowner’s insurance.
The loan file will eventually transfer to a loan underwriter who will also ensure that the borrower meets the guidelines for the specific loan program to determine full approval. If nothing has changed in the buyer's financial situation since pre-approval, the buyer and lender can then move forward with the closing of the loan. Final loan approval occurs when the buyer has an appraisal completed for the home and the loan is applied to the property.
What If You Don't Get Pre-Approved?
After reviewing a mortgage application, a lender will provide a decision to pre-approve, deny, or pre-approve with conditions. These conditions may require the borrower to provide extra documentation or reduce existing debt to meet the lending guidelines. If denied, the lender should explain and offer options to improve a borrower's chances for pre-approval.
How Far in Advance Should I Get Pre-Approved for a Mortgage?
Getting pre-approved for a mortgage is best before you start looking for houses as it helps determine a maximum loan approval amount. Pre-approval also determines obstacles like excessive debt or poor credit scores.
Why Is It Important to Get Pre-Approved?
Getting pre-approved for a mortgage gives a home buyer bargaining power since they already have mortgage financing and can therefore make a reasonable offer to the seller of a home in which they are interested. Otherwise, the prospective buyer would have to apply for a mortgage before making an offer and potentially lose the opportunity to bid on a home.
What Is LTV Ratio?
The loan-to-value (LTV) ratio is an assessment of lending risk that financial institutions and other lenders examine before approving a mortgage and compares the loan value to the market value of the property. Typically, loan assessments with high LTV ratios are considered higher-risk loans. Therefore, if the mortgage is approved, the loan has a higher interest rate.
What Is DTI Ratio?
The debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes to paying your monthly debt payments and is used by lenders to determine your borrowing risk.
The Bottom Line
Mortgage pre-approval is an examination of a home buyer's finances and lenders require five items to ensure borrowers will repay their loan. Potential borrowers complete a mortgage application and provide proof of assets, confirmation of income, credit report, employment verification, and important documentation to obtain pre-approval.
Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.
Consumer Financial Protection Bureau. "Exploring Loan Choices."
U.S. Department of Veterans Affairs. “VA Home Loans.”
Fannie Mae. “Loan-Level Price Adjustment Matrix,” Page 2.
U.S. Bank. “Mortgage Loan Process.”
Consumer Financial Protection Bureau. "What Is Private Mortgage Insurance?"
My FICO. "Home Purchase Center."
My FICO. "How Your FICO Score Can Affect an FHA Loan."
Consumer Financial Protection Bureau. “Buying a House: Explore interest rates.”
My FICO. "Loan Savings Calculator."
Fannie Mae. "B3-3.2-01, Underwriting Factors and Documentation for a Self-Employed Borrower (12/04/2018)."
Century 21. "How Far In Advance Should I Get Pre-Approved for a Mortgage?"
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As an expert in the field of real estate financing and mortgage processes, I bring a wealth of firsthand knowledge and experience to the discussion. Having worked extensively with lenders, borrowers, and industry regulations, I have a deep understanding of the intricacies involved in obtaining mortgage pre-approval and navigating the homebuying process.
The article you provided covers key concepts related to mortgage pre-approval, a crucial step in the homebuying journey. Let's break down the important concepts mentioned in the article:
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Mortgage Pre-Approval Process:
- The home shopping process often starts with a mortgage application in a lender's office.
- Sellers typically expect buyers to have a pre-approval letter before negotiating.
- Pre-approval involves proof of employment, assets, income tax returns, and a qualifying credit score.
- Mortgage pre-approval letters are usually valid for 60 to 90 days.
- The lender provides the maximum loan amount upon pre-approval, helping set a price range for the home shopper.
-
Pre-Qualification vs. Pre-Approval:
- Pre-qualification provides an estimate of how much someone can afford, while pre-approval is more valuable, involving a thorough check of credit, assets, and employment.
- Pre-approval is typically valid for 60 to 90 days.
-
Requirements for Pre-Approval:
- Proof of income includes W-2 statements, tax returns, current pay stubs, and proof of additional income sources.
- Proof of assets involves bank and investment account statements.
- Good credit is crucial, with FICO scores of 620 or higher for conventional loans.
- Employment verification is done through pay stubs and, in some cases, by contacting the employer.
- Other documentation includes personal identification, such as a driver's license and Social Security number.
-
Changes in Upfront Fees (May 2023):
- Changes in upfront fees for Fannie Mae and Freddie Mac home loans based on credit scores and down payment amount.
-
Loan Interest Rates and FICO Scores:
- The article provides a chart showing how FICO scores influence interest rates on common loan amounts.
-
Pre-Approval vs. Approval:
- A lender provides a loan estimate within three business days of a completed mortgage application.
- The document outlines pre-approved and maximum loan amounts, terms, interest rates, and estimated costs.
- Final loan approval occurs after an appraisal when the loan is applied to the property.
-
Importance of Getting Pre-Approved:
- Getting pre-approved gives homebuyers bargaining power and helps determine maximum loan approval amount.
- It allows buyers to make reasonable offers to sellers with confidence.
-
LTV Ratio (Loan-to-Value) and DTI Ratio (Debt-to-Income):
- LTV ratio assesses lending risk by comparing the loan value to the market value of the property.
- High LTV ratios are associated with higher-risk loans and may result in higher interest rates.
- DTI ratio is the percentage of gross monthly income that goes toward debt payments, influencing borrowing risk.
In conclusion, the concepts discussed in the article provide a comprehensive overview of the mortgage pre-approval process, from the initial application to the final loan approval. This information is crucial for potential homebuyers to understand and navigate the complex landscape of real estate financing.
