Investment Glossary – Mortgage Preapproval

The home-buying process has a few twists and turns in it for most people. It’s rarely a completely linear path from start to finish. One of the ways that prospective buyers can take a big chunk of excitement or panic out of the process is by getting a mortgage preapproval before making any offers on a home. I say “big chunk” because a mortgage preapproval does not mean you are fully approved for your loan and ready to go, but it sends significant signals to two parties. The first signal is to the sellers of the home that you are looking at, signifying that you are serious about buying a property and not wasting their time, and the other signal is to you and your family that your thoughts on what you can afford are in line with what banks are willing to lend you.

A mortgage preapproval is something you should obtain before you start seriously thinking about placing offers on properties if you need or want to take out a mortgage to buy real estate. You can go to open houses and you can poke around on Zillow or Trulia, but it is highly recommended that you have a preapproval in hand before you actually make an offer on a home. Why? Because there will be other people who do have one, and if you don’t, it doesn’t matter how good you think your offer is. Sellers want third-party verification that you can actually come through on the offer you’re making.

So what is a mortgage preapproval?

It’s a letter from a bank stating that you are qualified to buy a home up to a certain price. Banks will ask for your tax records, pay stubs, statements from any accounts you may use to fund a down payment, and they’ll also do a hard pull of your credit report as they start the process of underwriting your mortgage. Lenders may ask for other information too, as each one may have slightly different requirements in their particular process. The underwriting process entails finding out as much financial information about you as possible, mostly to see if you have a low enough debt-to-income ratio to afford your potential mortgage. Lenders also want to learn about your financial history to see if you have any bad habits with debt in your past that may make your loan risky for the bank in the future. This process should also be helpful for potential buyers since you can learn a little about what potential principal and interest payments on a mortgage could look like and get a sense of any issues you may have to clean up before you go further in your search.

It is important to remember that a preapproval does not mean that you are done with underwriting. Once you have an offer accepted on a property, your lender will go through a more in-depth process, likely following up with you right up until the closing date for your purchase. So while the preapproval is a great signal to a seller that you are ready to buy their house, it doesn’t mean you have reached the finish line with your lender. There is still a lot of work that needs to be done, but a mortgage preapproval can be a big step in the right direction as you begin the process of buying a home.