You’ve been searching online for just the right home, cruising neighborhoods looking for the “that’s it!” house and picturing yourself on your shady new porch. You know there’s plenty to do before you get to the really serious house hunting, but it’s hard to resist.
Hang on, you’re almost there. You’ve got to have one thing in hand before the fun begins: your preapproval letter
Hang on, you’re almost there. You’ve got to have one thing in hand before the fun begins: your preapproval letter.
PREQUALIFIED OR PREAPPROVED?
Mortgage terminology can be confusing. One important milestone to becoming a serious buyer is understanding the difference between being prequalified and preapproved.
Prequalifying means you’ve been initially screened by a lender. It is only getting your foot in the door. Usually, you will submit some basic information, and the lender will provide a rough estimate of what you might be able to afford. Frankly, this won’t help much in your efforts to seal a handshake deal on a home.
On the other hand, preapproval takes the preliminary loan process a step further. Additional financial information is gathered, likely including a credit report. In some instances, you might be asked to provide many of the same documents that will be required to complete the actual loan process, including tax returns, bank statements and employment verification. With a preapproval letter from your lender, real estate agents and sellers know you are a serious buyer.
This letter can be shown to sellers when bidding on a property. It proves that you already have backing and the ability to go through with the sale, which makes you a much more attractive buyer to sellers.
WHAT DOCUMENTS WILL YOU NEED?
We mentioned you’ll need to provide some information when applying for preapproval, to demonstrate your financial history and reliability. This may include:
- Personal information such as your driver’s license, Social Security number, marital status, contact information and address.
- Recent statements from your bank accounts and any investment accounts. (Exactly how far back you’ll have to go depends on the lender.)
- Employment information, including where you have worked and for how long, as well as recent paycheck stubs and W-2 income tax forms for the last two years.
- Your total monthly expenses, which includes bills you pay regularly.
- Your overall financial condition, which includes all of your assets (stocks, 401(k), IRAs, bonds, cash) and all of your liabilities (any debts such as credit card debt, student loans, car loans).
- Profit and loss statements if you are self-employed.
- Rental property income.
- Canceled checks for rent, which shows your payment history.
- Gift letters, if you are using a gift from a relative to help cover the down payment.
It’s helpful to create a folder in Google Drive or Dropbox where you can upload and update all documents in one place. If you wind up ultimately choosing a different lender than the one you used for your preapproval, you’ll be able to share documents with just a few clicks.
PREAPPROVALS AREN’T A SURE THING
A mortgage preapproval letter puts you head and shoulders above other buyers who may be interested in the same home as you are — but it’s not a guarantee. The preapproval process does not include a full-fledged underwriting review by the lender, so it’s not an absolute commitment to issue you a home loan, though it is pretty close. There may even be conditions listed on the preapproval that are contingent to receiving a loan.
While a preapproval is proof that a lender is willing to make you loan, it is not an official commitment until you complete the full due diligence and application process. Other matters during the closing process can trip things up, including an appraisal of the home’s value and your ability to make a sufficient down payment.
WHEN PREAPPROVAL ISN’T NECESSARY
There can be good reasons to skip loan preapproval when house hunting. If you’re doing preliminary research on an area that is simply a potential new home base — checking out home prices, schools and lifestyle — it’s best to wait until you have a better idea of what you’re willing to spend, and where.
Also, delay preapproval if you need to iron out some wrinkles in your credit history. Pulling your credit score and then determining what improvements can be made should be done before seeking preapproval for a loan.
However, if your credit is solid and you’re on good financial footing, a preapproval will give you the confidence and flexibility to do some serious house hunting. Your real estate agent might work even harder to find you the perfect property, and you’ll have more leverage when negotiating a price.
WHAT YOUR PREAPPROVAL LETTER SAYS
A typical preapproval letter will contain language similar to this:
“This preapproval is issued based on your current credit history, income, assets and debt — assuming that there are no changes in your financial situation. This preapproval should not be considered a commitment to lend until the following conditions are met:
- A valid sales contract is initiated on a specific property
- A satisfactory appraisal is completed on such property
- You select a mortgage program, which allows your mortgage payment to fall within the preapproved amount
- And a rate commitment is issued by our company under the above-referenced mortgage program.”
The letter will often state an approximate purchase price that you qualify for, and usually an expiration date, often within 90 days.
NOW CAN WE SHOP?
OK, let’s say you’ve received that precious piece of paper. You’re in the game; practically packed and moving to your next address. A couple of quick reminders:
As we’ve noted earlier, even a preapproval letter is not a guarantee. In fact, a lender’s underwriting department can’t issue a firm loan offer until a specific property has been identified. It’s likely you haven’t gotten quite that far yet.
Lenders want to have some wiggle room in case your financial situation changes between the time you obtain the letter and when you actually find a home and complete the loan approval process. That means it’s important to:
- Keep your finances operating smoothly in the meantime
- Avoid opening any new credit accounts — for furniture or anything else you’ll be planning for your new address
- Keep existing lines of credit paid up and without substantial balance increases.
Having a preapproval letter in hand is often required in order to place a bid. A loan preapproval might not be a home run, but it will get you on base.