Unlocking Your Dream Home
Across the United States, even though interest rates are up more than double from their pandemic lows, 60% of homes are still selling in under a month. Typically, in most major metro areas, good homes are under contract in just a couple of weeks.
If you’re shopping for a new home in 2024, you need to act quickly – and that means getting a pre-approval letter from your mortgage lender to make sure you’re ready to put an offer in.
Pre-Qualification vs. Pre-Approval
But first, a pre-approval letter is different from a pre-qualification letter. It’s an important distinction since knowing the difference between the two will help you in your home-buying journey.
Put simply, a pre-approval letter is one step above a pre-qualification letter. If you’re pre-qualified, it means that the lender has approved you for a mortgage based on your stated information. If you went on a mortgage lender’s website and said that you make $150,000/year and have no debt, the lender will then send you a pre-qualification letter saying that – if that information is true – you qualify for a mortgage. Home sellers and realtors don’t find this information to be very reliable, since it hasn’t gone through review.
A pre-approval letter, on the other hand, means that the lender has taken the time to look through your documents. They’ve crossed their t’s and dotted their i’s. They’ve made sure that you aren’t missing anything and that your information is accurate and up-to-date. When it comes time to apply for the loan, unless something drastically changes with your financial situation, a pre-approval letter means that you’ll likely be approved for a mortgage loan.
The Pre-Approval Checklist: 5 Things You Need for a Mortgage
Here are five things you’ll need to get that pre-approval letter so you’re one step closer to an approved mortgage.
1. Tax Documents
Every lender is different. While we can give you a cursory overview of what most lenders expect, things might change based on your specific situation.
However, almost all mortgage lenders will require at least two years of tax returns, or W-2s, as proof of income. After all, the bank wants to know that you’ll be able to pay off the mortgage: if you’re only making $20k/year, it might be difficult to show a mortgage lender that you can pay off a $200k loan.
Tax returns give mortgage lenders a no-nonsense way to verify that you’re making enough money to be approved for a mortgage, so they’re a requirement across the board. If you’re self-employed and your adjusted gross income looks a bit lower on paper than it is due to tax write-offs, lenders are sometimes also willing to consider bank statements in addition to these tax documents.
2. Credit Report
In the same vein, mortgage lenders like to see that you have a good credit score, usually in the range of 620-800+. A credit score is a way for lenders to keep track of how likely you are to repay your debts. If you forgot about applying for a credit card from Macy’s three years ago to get 20% off a pair of jeans, that might haunt you.
If you’ve just started shopping for a home, it’s a good idea to request a copy of your credit score from Equifax, TransUnion or Experian. These are the three major credit bureaus that monitor your credit report and generate your score. However, you’ll need to be careful: some credit reports generate a “hard inquiry,” which might hurt your credit score.
Before you apply for an official copy of your credit report, check the websites for any existing credit cards that you have. Sometimes, they’ll also have a free credit reporting tool, and that can give you an idea of where you stand.
3. Personal Identification
According to the Federal Reserve, anywhere from 600,000 to 1.2 million people experienced mortgage fraud in 2020. Lenders are always on the lookout for fraudsters. Mortgage lenders want to make sure that they’re lending to the right person, so they’ll require you to provide some personal identification documents, including:
- Driver’s license or state-issued ID.
- Passport.
- US Alien Registration card.
- Social Security Number.
- Sometimes, an Individual Taxpayer Identification Number.
4. Employment Verification
To verify that your employment is up-to-date, most mortgage lenders will ask you to supply pay stubs from the last 30 days and a letter of employment verification from your employer.
While the past two years of tax returns might show that you’ve made enough money to qualify for the loan, the lender will still want to double-check that you haven’t lost your job since you applied for the mortgage.
5. List of Debts
Even if you make $300k/year, if you spend $290k/year on credit card bills, auto loans and student debt payments, you still won’t be able to qualify for a home. Lenders want to see that your debts are manageable, which means a debt-to-income ratio of 42% or lower after the mortgage is factored in.
For example, if you make $3k/month and have an auto loan of $250/month and a student loan of $50/month, you have a debt-to-income ratio of 10%: ($250 + $50 = $300; $300 / $3,000 = .1 or 10%).
If you plan on taking out a mortgage that will cost you an additional $1200/month, that will push your debt-to-income ratio to 50%. Most lenders see that amount as too risky.
If this all sounds massively confusing, that’s okay: the lender will take care of it for you. To make their jobs easier, prepare a list of debts that you currently owe, which might include:
- Student loan payments.
- Auto loan payments.
- Credit card bills.
- Personal loans.
At a Glance: 5 Things You Need to be Pre-Approved for a Mortgage
In short, the five things you’ll need to be approved for a mortgage include the following:
- Two years of tax returns / W-2s.
- A 620+ credit score.
- Personal identification information (Social Security number, state-issued driver’s license, passport, etc).
- Employment verification (letter from employer, two months of bank statements and/or pay stubs).
- List of monthly debts.
If you get these, you’ll be well on your way to being approved for a mortgage loan.
Read on to learn all about a reverse mortgage.