The number one piece of advice for homebuyers in today's market is to get preapproved before you start looking for a home. While a mortgage preapproval doesn't guarantee a purchase, it does give you an idea of how much you can borrow, your monthly payment and documented proof to a seller that you can qualify for financing.
"You wouldn't go to the grocery store without your wallet and you shouldn't shop for a home without a preapproval for a mortgage," says Dominic Turano, branch manager for First Home Mortgage in Washington, D.C.
Turano says most Realtors won't discuss properties with you until you have a mortgage preapproval.
Preapproval vs. prequalification
Peter Boyle, a senior loan originator at Summit Mortgage Corp. in Plymouth, Minn., recommends discussing financing with a mortgage lender about four months before you start actively looking for a home.
"If you apply for a loan early you have an opportunity to work on things that need to be changed or shored up without a gun to your head," says Boyle.
Lenders vary in how they handle a preapproval. Some still offer an initial prequalification rather than a preapproval.
"There are three pieces that make up a mortgage approval: your credit, your income and your home equity or down payment," says Aiman Abozeid, branch manager for Inlanta Mortgage in Madison, Wisc.
"When you prequalify someone for a loan, your loan originator will check your credit and ask you about your income and your down payment. If your credit is acceptable, a lender can give you a prequalification and an idea of the amount you can borrow."
A preapproval, says Abozeid, takes this a step further and runs your financial information through an automated underwriting system that checks your credit and debt-to-income ratio and generates a preapproval letter if you qualify.
The requirements for preapproval vary by lender and your individual circumstances, but typically, says Turano, you'll need to provide:
- 30 days of pay stubs
- Two years of federal tax returns
- 60 days or a quarterly statement of all asset accounts including your checking, savings and any investment accounts
- Two years of W2s
"If you have any unusual income or circumstances, you'll need to provide other documents," says Boyle. "For instance, if you're divorced, I need to see a decree. If you filed bankruptcy, I need a full copy of the discharge documents. If you have rental income, I need a copy of the lease."
In addition to paperwork, your preapproval session with your lender should include a discussion about your down payment and loan options.
Down payment and loan options
"It's important to have a paper trail of where your down payment and closing cost funds are coming from," says Abozeid. "You can't use any undocumented 'mattress money' for your down payment or money you've deposited from a credit card withdrawal or gambling winnings. If you have any odd deposits you'll need to document them with deposit slips and an explanation to make sure they aren't unauthorized gifts."
Turano says a good lender will ask a lot of questions during preapproval about your budget and your cash availability in order to offer some guidance on loan programs.
"Even within a 30-year fixed-rate loan program there are lots of options for FHA, VA and conventional loans," says Turano.
Turano provides borrowers with a maximum loan amount including estimated closing costs and monthly payments based on the projected down payment.
"I educate borrowers on the merits of various loan programs and run through different scenarios based on what they feel they can afford for their cash investment and their monthly payments," says Boyle.
To improve your chances of turning your preapproval into a closed loan, Turano recommends being completely honest with your lender from the beginning, especially if there's something unusual about your finances. He also provides a checklist of things to avoid after your preapproval that could cause problems, such as transferring money between accounts and applying for new credit. He recommends keeping all financial documents available such as tax returns and saving every bank statement and pay stub in case they are needed.
"Your finances are going to be under a microscope," says Boyle. "We need to be able to track everything."
A loan preapproval can be "pretty painless," says Turano, as long as you are prepared with appropriate documents.
Michele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time," has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT's REIT magazine and numerous Realtor associations.