How to Prequalify for a Mortgage

Mortgage Prequalification vs. Preapproval

The terms prequalification and preapproval sound the same, and with other types of loans, they may be used interchangeably. But with a mortgage loan, they're two distinct steps in the approval process.

Prequalification involves a lender's high-level review of your financial situation to give you an estimate of how much house you can afford if you were to qualify for a loan. It's not a required step in the mortgage process, but it can be a good way to estimate your home affordability.

Preapproval, on the other hand, gives you a more accurate idea of your approval odds, along with an estimate of the interest rate and other terms you can expect. It's also a required step in the process. Here are some more general differences between the two:

How Much Can I Prequalify For?

Lenders calculate an estimate of how much house you can afford based on several factors, including your gross income, monthly debt payments, credit score, expected down payment and potential loan terms.

There's no universal formula that lenders use to calculate how much you can prequalify for. However, several lenders offer prequalification calculators you can use to approximate your mortgage affordability. That said, here's a quick guide you can use.

1. Calculate Your Debt-to-Income Ratio

The amount you prequalify for is largely based on how much you can afford to pay each month, which is why your debt-to-income ratio (DTI) is critical. To calculate your DTI, add up your monthly debt payments and divide the sum by your gross monthly income. For example, if you earn $7,000 per month and have $1,500 in monthly debt obligations, your DTI is about 21%.

Lenders typically prefer a DTI under 43%, including your anticipated mortgage payment, though some may go as high as 50%. Additionally, your mortgage payment alone may be capped at 28% of your gross monthly income.

With $7,000, for instance, you may be capped at a payment of $1,960 per month, including principal, interest, taxes and insurance. Keep in mind, though, that that would put you at a total DTI of about 49%, which is on the high end of what lenders may accept. At the 43% threshold, your housing payment would be $1,510.

2. Estimate Your Loan Terms

Once you have an idea of how much you can afford to pay each month, you can use potential loan terms to back into an estimated loan amount. Here's what you'll need:

• Credit score: You'll typically need a FICO^® Score^☉ of credit score of 620 or above to get approved for a conventional loan, though some government-backed loan programs may accept lower scores. You can check your FICO^® Score for free with Experian.
• Interest rate: Once you know your credit score, you can estimate your interest rate using FICO's loan savings calculator.
• Down payment: A home down payment reduces your principal loan amount and, therefore, your monthly payment. The more money you can afford to put down, the more house you can afford without exceeding DTI limits.
• Repayment term: The standard repayment term for a mortgage loan is 30 years, but some lenders may also offer 10-, 15-, 20- or 25-year term options. While a shorter repayment term can help you secure a lower interest rate, it'll result in a higher monthly payment.

3. Put It All Together

Once you've evaluated your financial situation, you can put it all together to gauge how much you can qualify for. To start, you'll use the following formula to calculate your loan amount:

PV = (PMT / i) (1 - 1 / (1 + i)ⁿ)

• PV: The present value of the loan, or the original principal balance
• PMT: Monthly payment
• i: Interest rate per month (the loan's interest rate divided by 12)
• n: The number of months in the loan term

Assuming you qualify for a 5.5% interest rate and plan on a 30-year repayment term, here's how you'd calculate your loan amount:

1. PV = (1,510 / 0.004583) (1 - 1 / (1+ 0.004583)³⁶⁰)
2. PV = 329478.51 (1 - 1 / 5.186768231084846)
3. PV = 329478.51 (1 - 0.192798281212354)
4. PV = 329478.51 x 0.807201718787646
5. PV = 265955.62

The estimated loan amount you qualify for is $265,955.62. Now, if you also plan to put down $30,000 on the home, add that to the loan amount for a total purchase price of $295,955.62.

How to Get Prequalified

While you can use an online calculator to get a rough approximation of how much home you can afford, you'll get more accurate details from a lender or mortgage broker. Here's how to get started.

1. Gather Your Documentation

While each lender can vary in terms of the documentation they require, you can generally expect to provide the following:

• Income information
• Personal information (so the lender can perform a credit check)
• Basic bank account information
• How much you want to borrow
• How much you plan to put down

At this stage, you may not be required to provide tax information, pay stubs or bank statements, but it's still good to have them on hand to make sure you provide accurate details.

Learn more >> Checklist of Documents You'll Need for a Mortgage

2. Review Your Credit

The lender will typically run a credit check, but it's still a good idea to review your credit score on your own to determine whether you're ready for a mortgage.

You can start by getting free access to your FICO^® Score and Experian credit report. While you can get approved for a conventional loan with a score as low as 620, you'll have a better chance of securing favorable terms if your score is in the mid to upper 700s.

If your credit needs some work, consider taking time to make improvements before proceeding.

Learn more >> How to Build Credit to Buy a House

3. Apply for Prequalification

If your credit and financials are in good enough shape to move forward, pick a lender or mortgage broker and apply. Keep in mind that you don't need to shop around at this point because you're just evaluating loan options and affordability.

Depending on the lender, you may be able to apply for prequalification online and get results the same day—sometimes within an hour.

Factors that Affect Your Prequalified Amount

As previously mentioned, there are several factors that influence how much you can afford to spend on a house. Here are some more details about each:

• Credit score: Your credit score is a key factor lenders consider because it indicates the likelihood that you'll pay your bills on time. The higher your credit score, the lower your interest rate and monthly payment will be. In other words, a high credit score can help you qualify for a larger loan.
• Down payment: The more you put down, the less you have to borrow. As such, a higher down payment can help you qualify for a more expensive home. What's more, a 20% down payment on a conventional loan can help you avoid private mortgage insurance, reducing your monthly payment even further.
• Loan term: Your desired repayment term will also influence your monthly payment. While a shorter repayment term can save you money on interest charges, it could result in a much higher monthly payment, reducing how much you can borrow with your new loan.
• Debt-to-income ratio: Your DTI is also critical because it tells lenders how much you can afford to spend on a monthly housing payment without putting too much strain on your budget.
• Employment history: In addition to your income, lenders will also want to look at your employment history. If you have a history of job-hopping or you have less than two years' worth of self-employment income, you may have a harder time getting prequalified.

How to Improve Your Chances of Getting Prequalified or Preapproved for a Mortgage

A mortgage loan is a significant financial commitment, so home lenders tend to have stricter requirements compared to other types of loans. As you prepare yourself for homeownership, here are some steps you can take to improve your odds of getting approved with favorable terms:

1. Check your credit score and report. Reviewing your FICO^® Score and Experian credit report can help you get a picture of your overall credit health and identify potential problem areas you can address. You can also obtain free weekly credit reports from all three credit bureaus (Experian, TransUnion and Equifax) through AnnualCreditReport.com.
2. Pay down existing debt. Reducing your credit card debt helps lower your credit utilization ratio, which is a major factor in determining your FICO^® Score. Additionally, completely paying off credit card and loan balances can reduce your DTI because it removes those monthly payments from the equation.
3. Look for ways to increase your income. Another way to lower your DTI is by increasing your income. Look for opportunities to take on extra work, and consider asking for a raise or consistent overtime hours. Additionally, you can include income earned from a side business. Just keep in mind that many lenders require two years' worth of self-employment income to include it.
4. Avoid borrowing leading up to and during the mortgage process. Any new debt you take on will impact your ability to get a mortgage loan, as well as your capacity to make payments. As such, some experts recommend that you avoid opening any new credit accounts for at least six months before you start the prequalification process.

Improving your credit and lowering your DTI can take time, especially if you've made some credit missteps in the past. But even a slightly lower interest rate could save you thousands or even tens of thousands of dollars on a mortgage. So, unless you're forced to make a decision now, take your time to ensure your credit is in good shape before you get prequalified.

How Does a Mortgage Prequalification Affect Your Credit?

As with other loan types, getting prequalified for a mortgage typically won't hurt your credit score. Lenders generally run a soft credit inquiry, which will show up on your credit report but won't impact your credit score.

If you decide to move forward to get preapproved, though, expect a hard credit check, which can affect your credit score negatively. That said, a single hard inquiry will usually have a negligible and temporary impact.

You can minimize the effect of hard inquiries on your FICO^® Score by completing your rate shopping within a short period of time. With newer FICO models, multiple mortgage-related inquiries made within a 45-day window are combined into one for scoring purposes.

Up Next: Mortgage Preapproval

There's no requirement to get prequalified for a mortgage loan. If you already have a good sense of how much you can spend and what you'll get approved for, you can jump straight into mortgage preapproval.

Getting preapproved is crucial because it tells you how much you're authorized to borrow, giving you more concrete information as you begin house hunting. Having a mortgage preapproval letter can also give you an advantage over other prospective buyers, especially in a seller's market.

Before applying for preapproval, make sure you have documentation to verify all of your financial information. You'll also want to submit applications with multiple lenders at this point to compare interest rates and other terms. Learn more about how to get preapproved for a mortgage loan before you get started.