Mortgage Preapproval: How Mortgage Preapproval Works

A mortgage preapproval is an assessment of a prospective borrower's financial health and credit history, which determines whether they are an attractive candidate for a mortgage loan. The borrower must submit financial records, such as credit reports and proof of income, assets, and identity, with their preapproval application. A real estate agent may help them compile these documents.

The lending institution will assess and then offer an approval, a denial, or an approval with conditions. If approved, the lender will provide the borrower with a preapproval letter indicating that their preapproval assessment met the criteria for a home loan. The borrower can then show this letter—typically valid for ninety days—to home sellers to make their offers more competitive and legitimate.

Preapproval is especially important for first-time homebuyers who must provide proof of loan eligibility to home sellers to get the best mortgage rate possible.

The main difference between prequalification and preapproval lies in the verification process. A mortgage preapproval is a thorough assessment, during which a lender examines a borrower's credit report and financial history to determine their loan worthiness. It can function as a working approval for a mortgage loan, in which a lender offers the borrower a loan at a specific interest rate. The documents in a preapproval application must go through underwriting, in which a third-party representative verifies the information in the application to complete the loan approval process.

For the mortgage prequalification process, prospective borrowers provide lenders with their financial information for assessment. The lender will then assess the borrower’s credit to give them a preliminary loan estimate. Because underwriters do not verify this information, there is no loan guarantee. Thus, getting prequalified for a mortgage is less involved than preapproval.

Lenders look at several factors to determine whether to grant prospective homeowners’ preapproval, including:

1. 1. Assets and liabilities: Any assets you own, including bank balances, stocks, bonds, and real property, will contribute to your loan eligibility. Liabilities that affect eligibility include unpaid loans or property liens.
2. 2. Credit history: Lenders will perform a thorough credit check and consider your current credit score when determining your loan eligibility. Your credit score is an assessment of your creditworthiness based on your timeliness and reliability with paying off loans.
3. 3. Debt-to-income ratio (DTI): Lenders use your debt-to-income ratio to compare your income and annual debts. If your income is not safely higher than your debts, lenders will view your ability to pay off the debt as a risk.
4. 4. Employment history: Your employment history will play a role in determining your mortgage preapproval. A mortgage lender will want to see a steady employment history to ensure your ability to pay off the loan.
5. 5. Loan-to-value ratio: This ratio is the requested loan amount calculated against the home’s total value. The loan-to-value ratio helps lenders determine the loan type, the loan term (or amortization schedule, which determines the life of the loan), and the interest rate that the borrower will pay off in monthly payments.

The mortgage preapproval process begins with the borrower compiling all necessary documentation for an assessment. Here is a breakdown of the process:

1. 1. Start the process early. Seek preapproval between six months and a year before house hunting for your new home and submitting your final mortgage application. Acquiring preapproval before you start house hunting will strengthen your credit position, show that you're a serious buyer, and provide you more time to save for your down payment and closing costs.
2. 2. Work with a real estate professional. The first-time mortgage approval process is complex, comprehensive, and has a series of potentially confusing steps. Consider working with a real estate professional (like an agent or a broker) to help facilitate the mortgage application process.
   
3. 3. Compile your preapproval loan application. A preapproval application requires providing information on the type of loan you’re applying for, along with personal details such as your social security number, employer and employment history, and financial details. You will also need to state whether the loan is for a purchase, a refinance, or new construction. Start by working with one lender, but shop for different lenders to get more competitive rates.
4. 4. Provide proof of assets and debt documentation. Your preapproval application should include documentation providing proof of assets—such as property, stocks, and other investments—as well as documents that show any monthly liabilities or debt payments like student loans or credit card debt.
5. 5. Provide proof of employment and income. Include letters from your current employers, as well as bank account statements and pay stubs that provide proof of income in your application. Typically, lenders will request sixty days’ worth of bank statements, thirty days’ worth of pay stubs, and tax returns from the previous year.
6. 6. Submit a credit report. A lender will often request a copy of your credit report from their preferred credit bureau in the preapproval application, but you can also provide them with one. Pulling your credit information and sending it to the lender will not impact your credit score.
7. 7. Submit your applications within forty-five days. If you’re applying for a loan with multiple lenders, submit all of your applications within forty-five days so that any credit checks count as one hard inquiry, making a minimum impact on your credit score.
8. 8. Provide proof of identity. Basic documents, such as a passport or driver's license, that provide proof of identity are among the pieces of documentation required in the preapproval application.

After submitting your preapproval application, the lender will assess the materials, then offer you one of three responses: an approval, a denial, or an approval with conditions. Conditions for approval include improving your credit score by paying off credit card debt or providing more information about employment history or income history. The lender should explain the reasons for your denial if your application is not approved.

The lender will provide you with an official preapproval letter when they approve your application. You can show this to home sellers as proof that you can provide the financing necessary for the home purchase. The approval letter typically expires ninety days after the lender writes it.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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