Step 1. Get Preapproved
Getting a mortgage preapproval should be at the top of every home buyer’s to-do list. Before you even bother to see what houses are on the market, you should be reasonably confident in how much money a mortgage lender is willing to let you borrow – and this comes with preapproval.
Until a lender preapproves you for a mortgage, many real estate agents won’t be willing to give you much of their valuable time – especially in a seller’s market. A preapproval letter, or a Verified Approval Letter, shows real estate agents and sellers you’re serious about buying a house and can make a competitive offer.
The Mortgage Preapproval Process
When you get preapproved, a mortgage lender pulls your credit. This gives your lender access to your credit score and your credit report. Here’s a breakdown of the main items that your lender will consider during the preapproval process:
Credit score: The credit score you’ll need will vary with the type of home loan you apply for. For an FHA loan, you’ll usually need a minimum score of 580, although some FHA lenders accept a score as low as 500. A credit score of 620 or higher should qualify you for a conventional loan with most lenders. A VA loan doesn’t require a specific score, but each lender sets its own credit score guidelines.
Debt-to-income ratio (DTI): The lender will also likely ask about your income, assets and outstanding debt to calculate how much home you can afford based on your DTI, which is expressed as a percentage after dividing the sum of your monthly debt payments by your gross monthly income. DTI requirements often vary from one lender to the next.
Credit history: In addition to your credit score and DTI, lenders will see whether you’re buying a house after bankruptcy or with collections on your record. It’s still possible to get a mortgage with negative items on your credit report, but you may only qualify for certain loan options.
During the preapproval process, you’ll be matched with a preliminary loan program. Some borrowers end up changing their loan type later on, but getting initial approval is crucial even if your situation changes.
Step 2. Prepare Your Documents
Most lenders require documentation of your debts, assets and credit history, along with proof of employment and income. The more information you can give your lender upfront, the stronger your preapproval will be because you and the seller will feel more confident that your loan will ultimately receive final approval.
Mortgage Application Documents
Let’s consider the documents you’ll need for the mortgage application process.
To verify your debts and assets, you’ll likely have to provide:
Bank account statements
If applicable, recent statements from your investment portfolio (retirement, stock and bond accounts, etc.)
If applicable, a gift letter and a receipt of gifted funds
Verification of any outstanding debts, such as auto loans or student loans
An explanation for any financial mishaps that might appear on your credit report, including bankruptcies, foreclosures or delinquencies
You’ll also provide verification of your employment and income. To do this, you’ll likely need:
The name, address and contact information of your current employer
2 years of W-2s
2 years of tax returns (1040 tax forms)
Profit and loss statements if you’re self-employed
Proof of child support, alimony or other income
You can provide income and asset documentation later on, at the underwriting stage, but submitting it upfront can give you a better understanding of how much home you can afford to purchase.
3. Determine Your Budget
Your preapproval letter will tell you how much money you can borrow. However, just because you’re preapproved for a certain amount doesn’t mean you should stretch your budget. Try using a mortgage calculator to determine a realistic estimate for monthly mortgage payments. In doing this, you’ll also want to factor in property taxes and homeowners insurance.
It’s important to make sure you have enough money left over every month to have a savings as well as cover all your other expenses along with any emergencies that might arise or any investments you plan to make. And don’t forget to also leave a little bit of room for personal enjoyment.