3 Steps to Take Before Seeking Pre-approval for a Mortgage

by Jessica Sommerfield · 6 comments

With interest rates rising and housing supply limited for the time being, many people are rushing to buy a home early this season. If you are one of these people, and unless you have cash ready to pay in full, then know that it’s especially important this time around to get pre-approved before you begin hunting for that dream home. With a competitive seller’s market, getting that proof gives you to a leg up because the seller knows you’re “good for it,” so to speak.

But, even before the pre-approval process, there are a few things to understand and get in order. Here are some steps that will ensure you get the home loan that’s right for you.

#1: Determine what you can afford.

Being assured by a lender that you’re approved to borrow a certain amount doesn’t mean you can afford the sum. Despite laws that hold lenders more accountable than before the housing crisis, these companies are still known for offering larger loans than borrowers can afford. So, how do you know what you can actually afford?

  • Look at what you’re currently paying for housing, and try to stick as close to it as possible.
  • Look at the whole picture. Calculate the true expense by combining the principal, interest, taxes and insurance (an easy acronym to remember is PITI). What’s your down payment? If it’s less than 20%, you may also need to factor in an extra $50 to $300 per month for mortgage insurance. Don’t worry about the math though — there are plenty of online calculators that can help!

#2: Know what you’ll need to provide.

To get pre-qualified, a lender will ask simple questions about your income, assets, and debt. Pre-approval means you’re offered a particular loan amount, so it’s a little more serious and comes with an application fee.

The lender will consider your debt-to-income ratio, your ability to repay the loan, and your FICO credit score (which influences your interest rate). To do this, they’ll run a credit check and ask for a list of financial documents, usually the following:

  • bank statements for the last few months
  • tax returns and W2s for the past few years
  • proof of employment and income (pay stubs)
  • anything else they believe could strengthen your loan application

Having these documents ready to go will streamline the process, especially if you’re in a hurry to beat the rising interest rates.

#3: Get your finances in shape.

Once you know what a lender will be looking for, work on anything that’s below standard.

For instance, have you held a regular job for at least a few months? Lenders look for job stability. If you’ve jumped around, or if you’re considering a career move, staying put for now might improve your loan terms.

Have you taken on any new credit accounts or loans or closed old ones? Recent shifts in credit, such as getting a bunch of credit cards even if your intention was just to grab those signup bonuses, can affect your debt-to-income ratio and perceived financial stability.

Finally, take a look at your credit report and score. Is it below 620? You might have trouble qualifying. Is it at or above 720? You’re in the sweet spot for the best interest rates. (To estimate interest rates based on your score, use this tool provided by the Consumer Finance Protection Bureau).

Simple things like making payments on time and paying off your credit card balance each month can improve your score and save thousands of dollars in interest over the lifetime of a loan. This process takes time though, so don’t expect to pay off the balance and expect to your score catapult to be comparable to someone who’s always paid off their credit card balances for years.

You really need to make sure you are ready to buy a house long before you even start planning to purchase that dream house. If a home is at all in your radar, then start immediately and get prepared well before looking for a good mortgage broker or lender. You’ll thank me for it later.

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  • Arminius Aurelius says:

    First of all I would say that there is no ” limited ” housing supply . As in the 2003 to 2007 era , housing , high rises and shopping malls are once again being overbuilt . And once again the prices have skyrocketed . This is NOT the time to consider buying a home . Both the stock market and the housing market are irrational and in the not too distant future both will CRASH as in the 2007 to the 2010 era. Buy low when everyone else is selling. Patience is a virtue that pays dividends .

    • David @ MoneyNing.com says:

      Valuations are extremely high. Hopefully rates will increase gradually and not at the swift pace that the Fed wants to raise them, as I fear that the economy/housing market won’t be able to absorb the changes easily.

  • Archie says:

    I’m so glad more people are understanding the importance of your first point. Many people are often surprised that a lender says they can afford X when really they should be looking far below that to prevent being “home-broke”.

    • David @ MoneyNing.com says:

      And I’m glad people like you are out there to inform the rest of us that lenders aren’t the people who can tell us what we can afford! Thanks for chiming in!

  • Stephen says:

    I think #1 is the most important. Lenders often give you an enormous approval. Often if people max that they’ll be underwater for an extremely long time or there’s a good chance of defaulting if interest rates go up. Canada just put in a few good controls to help prevent that. You basically need to qualify for your mortgage at a much higher interest rate than what you would be paying. This helps ensure people can make payments if the rates go up.

    • David @ MoneyNing.com says:

      Is a variable interest rate mortgage common in Canada? Is that why people need to be approved for a higher interest rate? I hear that parts of the Canadian market is in an even bigger bubble than what we have in the States, so I really wish those people luck!

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