What Is a Preapproval Letter?

Mother and daughter hugging in new house

A preapproval letter is a document that states how much a lender is willing to loan you for a new home. Having one helps you understand how much home you can afford, and can give you an advantage when bidding on property against other prospective homebuyers. Keep reading to learn about how mortgage preapprovals work, how to get one and why you might want one.

Difference Between Preapproval and Prequalification

Although the terms are sometimes used interchangeably by lenders, there are key differences between a mortgage prequalification and a mortgage preapproval.

A prequalification indicates the lender has reviewed your credit profile and financial information to determine your approval odds. Lenders may use information you provide, or they may access your credit data through a soft inquiry that won't impact your credit score. You will typically need to provide your annual income, housing payment, monthly debt obligations and savings account balance for the lender to review.

Getting prequalified helps you compare your options, but it's still only the first step in the typically lengthy mortgage process. The lenders will need to analyze your finances much more closely before they'll officially approve you for a loan. If you're having trouble getting prequalified, you can speak with a loan officer to see if there are ways to reverse their decision or you might take it as a sign to move on to another lender.

The mortgage preapproval process entails a detailed review of your finances and could take some time. The process is essentially the same as what you'd have to do when officially applying for a mortgage. You will be required to submit financial documentation to the lender for review. Also, expect a hard inquiry on your credit report, which could impact your credit scores (though it shouldn't have much of an impact, if it has any at all).

Having a mortgage preapproval in hand is beneficial when home shopping as it may give you a competitive advantage over other buyers. It is not a guarantee your loan application will be approved, but preapproval at least shows the seller you mean business and are likely to secure the financing needed to seal the deal. Furthermore, some sellers require a prequalification or preapproval letter before they will consider or accept your offer.

How Does a Preapproval Letter Work?

If your loan application is preapproved, the lender issues a letter that's valid for a certain window of time, such as 30, 60 or 90 days. This letter outlines the terms of the offer, including the maximum allowable purchase price, any applicable lending fees and the interest rate the lender has tentatively agreed to extend you.

When you're ready to move forward with the mortgage process, the lender may ask for updated financial documents. Some also pull your credit again to see if anything has changed and may adjust the loan offer. If market conditions have changed, you may be offered a higher or lower interest rate.

Does Mortgage Preapproval Affect Your Credit?

A mortgage preapproval results in a hard inquiry on your credit report and can lower your credit score by a few points. This shouldn't deter you from shopping around to secure the best rate, though. The score impact is only temporary, and credit scoring models recognize hard credit pulls that are a result of applying with multiple lenders to secure the best possible rate (also called rate shopping). Mortgage inquiries that occur within a brief time period are consequently combined into one inquiry, which helps to minimize score effects. The FICO® Score models merge inquiries made within a 45-day window, and the VantageScore® model allows you two weeks to get rate shopping done.

So, you're free to explore what different lenders can offer you without fear of ruining your credit score. You can also opt for a prequalification instead of a preapproval to get a more basic idea of which lenders might be best.

How to Get a Preapproval Letter

Before you start shopping for a mortgage, it's important to know what the lender will need to process your application. Gathering these documents in advance will help expedite the review of your mortgage application so you can get preapproved:

  • Proof of identity: The lender will need a copy of your driver's license or passport and your Social Security number.
  • Proof of income: You will need to provide pay stubs, tax returns and bank statements from the past two years. If you're self-employed, the lender will average the income from these returns.
  • Proof of assets and debts: Lenders want to know that you have the funds to cover your down payment and closing costs. It's equally vital that you have additional funds on hand, also known as reserves, to cover your mortgage if you lose your job or your income goes down. You will also need to disclose any debts that do not appear on your credit report.

Note that documentation requirements vary by lender and loan type. You can start your application on the lender's website, at a branch or by speaking to a loan officer by phone. Also, know that an application fee may apply, and you will have to authorize the lender to perform a credit check.

You could receive a preapproval letter in as little as one business day. If you're self-employed, or your preapproval application requires additional verification, it could take up to two weeks to hear back from the lender regarding your application.

The Bottom Line

A mortgage preapproval is a great way to know if you're likely to be approved for a home loan. It also shows sellers that you are a viable candidate and can give you bargaining power when bidding on your next home.

Before you submit a mortgage application to get preapproved, it's best to check your credit report and scores to see where you stand. Dispute any inaccuracies right away and take care of any other factors that could be impacting your credit score to give yourself the best chance at getting approved for a home loan with competitive terms.

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