After a long day of yardwork, you decide to visit a luxury car dealership to test drive their latest model, without bothering to shower or change. Do you think that they'll take you seriously? That's a lot like placing an offer on a home without a pre-approved mortgage loan.
More than wearing a nice suit, a pre-approval for a mortgage shows the seller that you are a serious buyer, and that you'll be able to afford the purchase. A pre-approval will let you know how much home you can afford, most home sellers will expect to see a pre-approval when your purchase offer requires a loan to complete the sale.
What Is a Mortgage Pre-Approval?
A mortgage pre-approval is produced by a lender that indicates how much you can borrow. The information in a mortgage pre-approval usually includes the amount you can borrow, the type of loan and the interest rate you qualify for. Unlike a mortgage approval itself, this document just states the lender's belief that it would approve your mortgage application based on the income and credit information that you've submitted. The information typically needed for a home mortgage pre-approval includes your personal information, credit history, credit score, income, assets, debts, tax returns and employment history.
Pre-Qualification Versus Pre-Approval
Many people tend to confuse a mortgage pre-approval with something called a pre-qualification. While these two names sound similar, the documents serve very different functions. A mortgage pre-qualification is an initial step that borrowers can take to get an estimate of how much they can borrow. A pre-qualification can occur quickly over the phone or online, and it's based only on basic information about the borrower's income, assets, and debts. In contrast, a mortgage pre-approval requires you to fill out a complete mortgage application, and supply much of the required supporting documentation.
And because there's no credit information included in a pre-qualification, it won't carry nearly as much weight with a seller as a pre-approval will. And unlike a mortgage pre-approval, a pre-qualification doesn't include any examination of your credit history or your credit score, or any impact on it. While a mortgage pre-qualification might not be sufficient for a purchase offer, some real estate agents may want to see it before working with a buyer.
The Mortgage Pre-Approval Process
Since a mortgage pre-approval requires you to submit a mortgage application, it's a detailed process. First, the lender will ask you for a variety of personal information such as proof of identity like a passport or a driver's license, as well as your Social Security Number. You'll also be asked to grant permission for the lender to view a copy of your credit reports and your credit score. In fact, it's best to have a lender perform an initial credit check as soon as you are considering purchasing a home, in order to ensure that there aren't any problems that you need to clear up before you actually apply for a loan. If you do find any mistakes information in your credit history, it could take weeks to correct it.
Next, your lender will ask you for information about your income. To document your income, you'll need to provide paystubs, bank statements and your tax returns for the last two years. If you aren't a W-2 employee, such as a business owner or a freelance worker, then the lender will use the average of the income you reported on your taxes over the previous two years.
The lender will also ask you about any assets and debts that you have. Assets can include savings, investments, and other properties you own. Most of your debts will appear on your credit reports, but you'll also be asked if you have any other outstanding loans.
Finally, you may be asked to pay an application fee, which could be rolled into the mortgage loan itself, along with the many other required fees. Most of the time, a lender can generate a pre-approval letter within a day of submitting your application. However, if you are self-employed, or there are other parts of your mortgage application that need additional verification, it can take up to two weeks to be pre-approved. And when you receive your pre-approval letter, it will state that it's valid for limited period of time, such as 60 or 90 days from when it was written.
How a Mortgage Pre-Approval Affects Your Credit
Since getting a mortgage pre-approval requires a credit check for the purpose of applying for a loan, it's considered to be a so-called "hard pull" on your credit report. A single inquiry is unlikely to have a significant effect on your credit score, however multiple inquires will normally cause your score to fall somewhat. The reasoning is that applying for several new loans may be a sign of financial stress that could affect their ability to repay a loan.
But what about a home buyer who might fill out several applications in the process of shopping for a new loan? Thankfully, the credit scoring models take this behavior into account, and only count several mortgage applications as a single inquiry, so long as they are made within a two week to 30 day period, depending on the scoring model used. This allows you to shop around for the best possible terms without worrying that each credit inquiry will harm your ability to qualify for a new loan.
There's nothing quite like the feeling of buying your first home, or just moving into a nicer place. However, this sense of accomplishment comes only after you've found a home, negotiated a contract and have been approved for a loan. An integral part of this process is completing a mortgage pre-approval. By understanding how a mortgage pre-approval works, and how to get one, you can be sure to put your best foot forward when you make an offer on your next home.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.
This article was originally published on September 15, 2017, and has been updated.