It’s an exciting time! You’re ready to begin the home-buying process by going house hunting and purchasing your dream home.
Before you start packing boxes, however, you need to get your financial affairs in order.
The first step in preparing to buy a home is getting mortgage pre-approval. To decide if you qualify for a home loan, lenders assess your credit history to determine your ability to make monthly payments and maintain a favorable financial situation.
To make the assessments needed for mortgage prequalification, lenders require documentation to verify income, assets, and expenses.
A checklist of documents to get started
As you begin the quest for a mortgage preapproval letter, you’ll have to turn over a bunch of documents containing financial information. Depending on the loan type and loan amount you’re pursuing, the required documentation can vary slightly.
Below is a checklist of the five most common documents you’ll need to prepare when you submit for your mortgage pre-approval.
1. Personal identification
To obtain a preapproval letter, you must provide a valid form of ID to prove your identity. State-issued driver’s licenses, passports, and US. alien registration cards are all acceptable forms of identification. You’ll also have to give the lender your contact information.
2. Social Security card
This is an added layer of identity verification. The lender can match your Social Security number with your personal identification to verify that they’re lending to the right person. Additionally, mortgage lenders will use your Social Security number to run a credit check.
3. Proof of employment
Borrowers will also have to show lenders evidence that they can afford monthly mortgage payments. As such, lenders will need proof of current, full-time employment.
When you’re applying for a mortgage, you’ll need to provide pay stubs that verify your monthly income. Additionally, lenders will require your tax returns (usually the two most recent W-2 forms) to confirm your long-term employment, further verify income, and assess other financial information.
If you’re self-employed, you’ll be asked to provide tax documents and business returns for the past three years. Additionally, the lender will request a year-to-date audited profit and loss statement. Whether it’s fair or not, self-employed individuals may have a harder time securing loans than their counterparts who work full-time for someone else — particularly if they’re first-time homebuyers.
4. Bank statements
Borrowers also need to show credit union and bank statements for the most recent two to three months to verify their ability to afford the down payment and closing costs (e.g., origination fees and underwriting expenses and, for home sellers, real estate agent commissions).
Additionally, lenders review bank account statements to confirm income deposits and uncover potential red flags. Large deposits from unknown sources, bounced checks, or evidence of insufficient funds can negatively impact your approval.
Investment accounts can help lenders recognize assets and other potential sources of income. that being the case, it’s a good idea to disclose additional financial information via investment account statements from your 401(k), 403(b), IRAs, stocks, bonds, and mutual funds.
Permission to pull your credit report
After you provide the required financial documents and other information, lenders will ask for permission to pull your credit report from one of the main credit bureaus before your mortgage application can move forward.
The credit report shows your payment history, the diversity of credit you have established (e.g., credit cards, mortgages, and car loans), and credit utilization. Essentially, it’s a way to gauge whether you are a serious buyer and are in the home-buying journey for the long haul.
Generally, your credit report will reveal a good credit score if you make on-time payments, consistently pay off debt, maintain a low credit utilization rate, and refrain from opening too many new lines of credit, due to hard inquiries.
On the flip side, if you’ve filed for bankruptcy, have delinquent accounts, and consistently use most of your available credit (e.g., maintaining high credit card balances), your credit score will be adversely impacted, which could reduce your mortgage options by making it harder to qualify for loan programs.
A good credit score of 670 or above will improve your chances of getting a loan with a decent interest rate. However, some lenders offer conventional loans to borrowers who have credit scores of at least 620. What’s more, some FHA loans can be offered to borrowers with credit scores as low as 500.
If your personal finance situation is less than ideal, you may still be eligible for a loan. Shop around to consider which lender and loan type is best for your needs.
Monthly expenses list
Part of the loan application process is to assess if you can take on more monthly debt. Loan officers want to know what fixed expenses borrowers are already responsible for each month, which helps them determine how much house they can afford and what purchase price is reasonable for their budget.
While your credit report will likely show the list of your fixed expenses, the lender may also ask you for more details. Fixed expenses are considered regular, recurring payments. Common expenses include:
- Current rent or mortgage
- Car loans
- Student loans
- Credit cards
- Medical bills
You do not need to disclose a list of variable expenses, such as gas or groceries. The fixed list of debts is more substantial for the lender to assess, as these expenses require a monthly minimum payment that you will always be responsible for making. Recognizing these fixed debts helps a lender determine your debt-to-income (DTI) ratio, which helps them come up with a better loan estimate for what you can afford.
Assessing your debt-to-income ratio helps lenders determine if you can take on more debt in the time frame you’re hoping to make a home purchase. This ratio shows how much money you have going out versus what you have coming in.
To qualify for a loan, you cannot exceed the maximum debt-to-income ratio, which varies depending on the type of loan you’re applying for. It’s wise to ask your lender about their debt-to-income ratio requirements because if you exceed the maximum, you may find out the hard way that your dream home is out of your price range.
In addition to the standard documentation that most applicants must submit, depending on your unique circumstances, you may be asked to provide supplemental documentation. In this section, we’ll highlight some of the other documents you may be asked to produce to determine your loan eligibility.
If you already own a home, you’ll likely be asked for recent mortgage statements to assess the equity in your home, principal balance, and current monthly payment. If you’re selling your home, this information can help lenders assess how much you should qualify for moving forward.
If you are keeping your home and applying for a new home mortgage to refinance, your current homeownership will be considered part of your debt-to-income ratio.
Lenders want to know if you can make your monthly mortgage payment on time. One way to assess this is to consider your rent history. As such, you may be asked to provide the names and contact details of former landlords. That way, lenders can verify whether you have consistently paid rent on time.
If a loved one provides a gift to help you cover the cost of your down payment, your lender will require a gift letter to prove this money is not a personal loan. (Remember, a personal loan would alter your debt-to-income ratio.)
If you’re receiving a gift, check with your lender about the rules regarding who can provide gift funds.
Preparing for a smooth pre-approval process
Getting a mortgage is your gateway to owning your own home!
Now that you know what a lender will expect, you’ll be prepared to manage the pre-approval process efficiently. By understanding what a lender will request, you’ll have a better idea about what mortgage rates you can afford, and you’ll be better prepared to prove that you’re a good candidate for a mortgage loan.
Keep in mind that this process is anything but a short one. You’ll have to wait several business days for your application to be processed. Still, you’ll want to move quickly once you get preapproved, because your mortgage preapproval letter will likely have an expiration date.
At this point, you know the ins and outs of the mortgage preapproval process. So what are you waiting for? Get the ball rolling and get that much closer to landing the home of your dreams.