A lender will conduct a preliminary evaluation of a potential borrower in order to determine whether or not they are eligible for a pre-qualification offer. This evaluation is known as a pre-approval. Relationships with credit bureaus, which facilitate pre-approval analysis through soft inquiries, are the source of pre-approvals, which are generated by these relationships. A prospective borrower can receive an estimated interest rate offer and a maximum principal amount from a lender through the use of pre-approval marketing.

What is a Pre-Approval

How does the qualification process for pre-approval work?

When it comes to obtaining marketing lists for pre-approval offers, lenders often work hand in hand with credit reporting agencies. The soft inquiry analysis that is used to generate pre-approvals gives a lender the opportunity to examine a portion of a borrower's credit profile information in order to ascertain whether or not the borrower satisfies certain lender characteristics. In most cases, the borrower's credit score will be the most important factor in determining whether or not they are qualified for pre-approval.

Types of Pre-Approval Offers

Direct mail and electronic mail are two of the primary channels through which financial institutions disseminate large volumes of pre-approval qualifications annually. These qualifications can be for credit cards, auto insurance, or private loans, for example.

In many cases, a pre-approved mortgage is not the same as a final offer on a mortgage. A pre-approval letter does not guarantee a particular interest rate. Lenders use pre-approval letters as a marketing tool for credit cards and other financial products.

The majority of pre-approval offers include both a unique code and a date by which they must be redeemed. When a borrower applies for credit, using the unique code that is provided by the lender can help to differentiate the application from other borrowers' applications and give the borrower some higher priority within the process of lending.

A borrower needs to fill out a credit application for the particular product in order to get a loan that has already been pre-approved. An application fee may be demanded by certain creditors, which can lead to an increase in overall loan costs. The borrower's income and social security number will need to be provided in the application for credit.

After the borrower has finished filling out the credit application, the lender will check the borrower's debt-to-income ratio and conduct a thorough investigation of the borrower's credit profile using a hard inquiry.

Even though a borrower may receive a pre-approval offer, this does not guarantee that they will be approved for the loan that is being offered.

The requirements for getting pre-approval on offers

In order for a borrower to be approved, the debt-to-income ratio of the borrower should be 36% or lower, and the borrower must meet the credit score qualifications set forth by the lender. The final underwriting analysis can frequently result in a significant difference between a borrower's pre-approved offer and the offer that is ultimately accepted for the loan.

Because credit card products have more standardized pricing and fewer negotiated fees, pre-approvals can typically be capitalized on more easily with credit cards than with other types of loans.

An approval for a credit card can typically be obtained online through the use of automated underwriting, whereas an application for a non-revolving loan may need to be completed in person with a loan officer.

Special Considerations

Because mortgage loans are acquired using secured capital, the pre-approved offer and the final offer for a mortgage will typically differ the most from one another. The process of underwriting must take into account an increased number of variables as a result of the presence of secured capital.

The credit score of the borrower is typically required for the underwriting process of a mortgage loan, in addition to two qualifying ratios: a debt-to-income ratio and a housing expense ratio. When obtaining a mortgage loan, the secured capital might also require an up-to-date appraisal, which will typically have an effect on the total principal that is provided.

 

Five Requirements for Mortgage Pre-Approval

Not at an open house, but at a lender's office, mortgage applications typically initiate the home-buying process. The majority of sellers anticipate that buyers will obtain pre-approval for financing and are typically willing to negotiate with those who can demonstrate their ability to obtain a loan.

Before negotiating with a buyer, a seller will frequently request a mortgage pre-approval letter.

A qualifying credit score and proof of employment, assets, and tax returns are required for preapproval.

Most mortgage pre-approval letters are valid for sixty to ninety days.

Upon pre-approval, the lender will provide the maximum loan amount, which assists the buyer in determining a price range.

Pre-Qualification vs. Pre-Approval

A pre-qualification for a mortgage can be useful as an estimate of how much a person can afford to spend on a home, but a pre-approval, which is typically valid for 60 to 90 days, is more valuable. It indicates that the lender has verified the borrower's credit, assets, and employment in order to approve a specific loan amount.

Consultation with a lender, obtaining a pre-approval letter, as well as discussing loan options and budgeting are advantageous for buyers. The lender will provide the maximum loan amount, which will help the homebuyer establish a price range. A mortgage calculator can assist buyers with cost estimation.

Requirements for Pre-Approval

Pre-approval for a mortgage requires a buyer to complete a mortgage application and provide evidence of assets, income, good credit, employment verification, and other essential documentation.

Depending on the type of loan, pre-approval is based on the buyer's FICO credit score, debt-to-income ratio (DTI), and other factors.

With the exception of jumbo loans, all loans adhere to Fannie Mae and Freddie Mac's standards. Some loans are designed for homebuyers with low to moderate incomes or first-time buyers. Veterans Affairs (VA) loans, which do not require a down payment, are available to veterans and service members of the United States.

1. Proof of Income

Potential homebuyers are required to provide W-2 wage statements and tax returns from the previous two years, current pay stubs indicating income and year-to-date income, and evidence of additional income sources such as alimony or bonuses.

2. Evidence of Assets

The bank and investment account statements of a borrower demonstrate their ability to pay the required down payment, closing costs, and cash reserves. The down payment, expressed as a percentage of the purchase price, varies depending on the type of loan. Many loans require the buyer to purchase private mortgage insurance (PMI) if the down payment is less than 20 percent.

3. Good Credit

The majority of lenders require a FICO score of 620 or higher to approve a conventional loan and 580 for an FHA loan. The lowest interest rates are typically reserved for customers with a credit score of 760 or higher.

The graph below illustrates the monthly principal and interest payment for a 30-year fixed-rate mortgage based on a range of FICO scores for three typical loan amounts. The Consumer Financial Protection Bureau's tool for calculating interest rates allows buyers to see how credit score, loan type, home price, and down payment amount affect interest rates.

On a $250,000 loan, a borrower with a FICO score between 620 and 639 would pay $1,288 per month, while a homeowner with a score between 760 and 850 would pay only $1,062 per month, a difference of $2,712 per year.

Since interest rates fluctuate frequently, use this FICO Loan Savings Calculator to verify your scores and interest rates.

4. Employment Verification

In addition to verifying employment through pay stubs, lenders will likely contact the borrower's employer to confirm employment and salary.

Self-employed buyers provide additional information, such as the stability of the borrower's income, the location and nature of the business, the financial strength of the business, as well as the ability of the business to continue generating and distributing sufficient income to allow the borrower to continue making mortgage payments.

5. Additional Documentation

Personal documents and identification required for pre-approval include the borrower's driver's license, Social Security number, and permission to run a credit report.

Pre-Approval vs. Approval

A lender must provide a loan estimate within three business days after receiving a complete mortgage application. It describes the pre-approved loan amount and the maximum loan amount, the terms and type of mortgage, the interest rate, estimated interest and payments, estimated closing costs, an estimate of property taxes, and homeowner's insurance.

The loan file will eventually be transferred to a loan underwriter, who will also confirm that the borrower satisfies the specific loan program's requirements prior to granting final approval. If the buyer's financial situation has not changed since pre-approval, the buyer and lender can then proceed with the loan closing. The final loan approval occurs after the buyer obtains a home appraisal and the loan is applied to the property.

What Happens If You Are Not Pre-Approved?

After reviewing a mortgage application, a lender will pre-approve, deny, or conditionally pre-approve the loan. The borrower may be required to provide additional documentation or reduce existing debt to meet these conditions. If pre-approval is denied, the lender must explain why and provide options to improve the borrower's chances of approval.

Frequently Asked Questions for Pre-Approved

How far in advance should I get my mortgage pre-approved?

Prior to house hunting, it is best to get pre-approved for a mortgage, as this helps determine the maximum loan amount that will be approved. Pre-approval has the obstacles like excessive debt or poor credit scores.

Why Is It Necessary to Obtain Pre-Approval?

A homebuyer who has been pre-approved for a mortgage has negotiating leverage with the seller of a home in which they are interested because they already have mortgage financing and can make a reasonable offer. Otherwise, the prospective buyer would be required to apply for a mortgage prior to making an offer, risking the chance to bid on a home.

What Is Loan-to-Value Ratio?

Before approving a mortgage, financial institutions and other lenders evaluate the loan-to-value (LTV) ratio, which compares the loan amount to the property's current market value. In general, loans with high LTV ratios are regarded as higher-risk loans. Therefore, even if the mortgage gets approved, the interest rate on the loan will be higher.

What Does DTI Ratio Mean?

Lenders use the debt-to-income ratio (DTI) to determine your borrowing risk by calculating the proportion of your gross monthly income that goes toward paying your monthly debt payments.

The Bottom Line

A mortgage pre-approval is based on a review of a home buyer's finances, and lenders require five items to ensure loan repayment. To obtain pre-approval, prospective borrowers submit a mortgage application along with proof of assets, proof of income, a credit report, employment verification, and other essential documentation.