When thinking about buying a home, one of the smartest things you can do is get your finances in order — even before you start looking at real estate.
That's because those initial steps (saving up for a down payment, strengthening your credit score) can streamline the process and position you for homebuying success. And there's a third step that is arguably just as essential: Getting a mortgage pre-approval from a lender can give you a sense of direction in your home search and a bit of an edge when it's time to actually submit an offer.
Wondering what it takes to get one, and if it's truly worthwhile for you? Read on for a quick primer on the pre-approval.
Essentially, a pre-approval letter is a document from a lender (a bank or financial company that lends money to borrowers when purchasing a home) stating how much money it is willing to lend to you to help pay for your home purchase.
A pre-approval isn't a hard-and-fast guarantee that you'll be granted a loan (for that, you'll need to go through the full underwriting process), "but it's enough to give you a ballpark on how much you can expect to spend," says Dustin Fox, a real estate agent with Pearson Smith Realty in Ashburn, VA. "It's similar to how a landscaper or a general contractor might give you a free estimate on their work."
In order to tell you how much you can afford to spend on a home, the lender will take a close look at the specifics of your financial situation — such as your income, assets, debt and credit history — to come up with what it considers the maximum loan amount for which you qualify.
It’s important to understand that a pre-approval is not the same as a pre-qualification, another type of document a lender may provide. With a pre-qualification letter, the number you’re given is based on your own estimates of your financial capabilities. On the other hand, with a pre-approval, your financials are vetted by the lender before you’re given a result. Since the pre-approval is based on a review of actual hard numbers, it carries more weight in a real estate transaction.
You may want to get pre-qualified as you start saving for a down payment to give yourself a target amount to set aside. Then, when you’re ready to start shopping for homes, you can talk to a lender and get pre-approved for a home loan; this can help you understand how much you can afford to spend on a home.
Getting a realistic idea of how much you can afford to spend on a home is just one of the benefits. Securing a pre-approval also enables you to prove to a seller that you’re financially capable of purchasing the home once you’re ready to submit an offer. In fact, “these days, you almost never see an offer submitted without a pre-approval attached,” says Fox. “If a seller is going to accept the offer and take their home off the market, they want proof that the loan will go through.”
The dollar value of the pre-approval can also be an important part of the negotiation process, according to Fox. “When we place an offer [on the buyer's behalf], we often call the lender and have them send over an updated pre-approval that is close to the offer price,” he says. “If the home is listed for $400,000 and you’re offering $390,000, you don’t want the seller to know that you could have gone much higher, but you chose not to.”
If a seller is going to accept the offer and take their home off the market, they want proof that the loan will go through.
A lender will ask you to provide some financial documentation when you apply for a pre-approval. The array will depend on your unique financial circumstance, but many lenders typically ask for these:
Once you provide these, it can take anywhere from a few hours to a few business days to receive your pre-approval letter.
During that time, the lender evaluates how much income you are bringing in each month versus how much is going out in debt payments. This helps determine whether you can likely handle taking on more debt in the form of a mortgage. Additionally, by checking your credit history, a lender can see how proficient you are in paying back your current debts.
If one lender won't sign off on the amount you seek, you can consider trying other financial institutions. Alternatively, many lenders are willing to counsel you on what you can do to improve your financial picture, and once you make those improvements, you can resubmit your application.
Since it may take some time to get the result you're hoping for, the earlier you can start the pre-approval process, the better. Then, once you have it in hand, you'll be one step closer to becoming a homeowner.
— With additional reporting from Life and Money by Citi editors.
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