Mortgage Pre-Approval: What Can I Afford?

If you're looking to buy a home, you may be wondering how much you can borrow for a mortgage. This process is known as mortgage pre-approval, and it's a way for lenders to check that you are creditworthy and able to repay the loan. To get pre-approved, you'll need to complete a mortgage application and provide proof of assets, confirmation of income, credit report, employment verification, and important documentation. Lenders will also look at your debt-to-income ratio (DTI) and your credit score. The higher your credit score, the better your mortgage rate is likely to be. Once you've been pre-approved, you'll receive a letter confirming the amount you're approved to borrow, which is usually valid for around two to three months.

Pre-qualification

However, pre-qualification holds little weight when making an offer on a home, and it is not a guarantee that you'll be approved for a loan. Since there is no hard credit check involved, the lender relies mainly on the information you provide. Therefore, it is less reliable than mortgage pre-approval. If you are confident about your credit and financial readiness to buy a home, you can skip the pre-qualification step and go straight to pre-approval.

Pre-approval is a more official step that requires the lender to verify your financial information and credit history. They will perform a credit check and review documents to confirm your income, assets, and debts. If you are pre-approved, you will receive a pre-approval letter, which is an offer to lend you a specific amount, good for 90 days. Pre-approval shows sellers that you are a serious buyer and can increase your chances of having your offer selected.

Pre-approval

To get pre-approved, you will need to provide the lender with detailed financial information. This includes proof of income, such as recent pay stubs, W-2 forms, or tax returns for self-employed individuals. You will also need to provide asset documentation, such as statements for your checking, savings, and investment accounts. Additionally, lenders will review your debt-to-income ratio, credit score, and consistent income and employment history.

It is recommended to check your credit score and report for any errors before seeking pre-approval, as a higher credit score can improve your chances of approval and help you qualify for better mortgage rates. Pre-approval can usually be obtained within 10 business days, and it is valid for 90 days.

Credit score

Your credit score is a critical factor in determining whether you'll be approved for a mortgage and the rate you'll pay. A higher credit score can help you qualify for better mortgage rates, while a lower score can lead to higher interest rates and increased costs over the life of the loan. Lenders typically look at scores from the three major credit reporting agencies - Equifax, Experian, and TransUnion - and use the middle score for deciding on the rate to offer.

A good credit score for a mortgage is generally considered to be 740 or higher, which will help you secure the best rates and save money by paying less in interest. A difference of just 100 points in credit scores can result in thousands of dollars of additional costs over the years. For example, a borrower with a credit score of 780 might get a 4% rate on a 30-year fixed-rate loan of $240,000, resulting in monthly payments of around $1,164. If their score drops by 100 points to between 680-699, the rate could increase to 4.5%, leading to a monthly payment of $1,216, an extra $62 per month or $744 per year. Over 30 years, this would amount to an additional $25,300.

It's important to note that your credit score is not the only factor considered by lenders. They also look at your income, debts, assets, and overall financial history. Pre-qualification and pre-approval are steps you can take to get an estimate of how much you might be able to borrow, and they can increase your chances of having your offer selected by sellers. During the pre-approval process, lenders will perform a credit check and verify your income, assets, and debts.

You can check your credit score and report before reaching out to a lender for mortgage pre-approval. It's recommended to review your credit report for any errors, as these can reduce your score and impact your mortgage rate. Additionally, avoid applying for new credit or opening multiple new accounts in a short period, as this can negatively affect your score.

Debt-to-income ratio

Your debt-to-income ratio (DTI) is a critical factor in determining your eligibility for a mortgage. It is a comparison between your monthly debt payments and your monthly income, and lenders use it to assess your ability to take on additional debt.

The DTI is calculated by dividing your total monthly debt payments by your gross monthly income (before taxes and other deductions) and expressing it as a percentage. For instance, if your monthly debt payments amount to $500 and your gross monthly income is $2000, your DTI is 25%.

Lenders generally view a lower DTI as favourable, indicating that you are less risky as a borrower. While the preferred DTI ratio varies across lenders, most prefer a ratio of 36% or below. A DTI higher than this threshold may suggest that you have excessive debt relative to your earnings, making it challenging to secure a mortgage or resulting in steep interest rates.

To improve your DTI, you can focus on paying off existing debts or increasing your income. Additionally, opting for a lower-priced home can help ensure your mortgage payments remain manageable relative to your income.

Before applying for a mortgage, it is advisable to get pre-qualified or pre-approved. Pre-qualification provides an estimate of your potential borrowing capacity, while pre-approval confirms your creditworthiness and indicates the specific amount a lender is willing to lend. Both options can be easily initiated online, over the phone, or in person, with pre-qualification requiring basic information and pre-approval involving a more comprehensive review of your finances and creditworthiness.

Assets and income

When it comes to applying for a mortgage, your assets and income are key factors in determining your eligibility. Lenders will assess your financial situation to gauge your ability to repay the loan. Here are some important considerations:

Income:

Lenders typically consider your income to be one of the most critical factors in the mortgage approval process. They will assess your income sources to determine if you can afford the monthly mortgage payments. Most lenders prefer borrowers with consistent and steady income from employment. However, self-employed individuals or those with irregular income can still qualify, provided they meet certain conditions. Lenders usually require a two-year history of stable income and employment in the same field or industry. They may also consider additional income sources, such as investment income, rental income, VA benefits, and military allowances for housing and food. It's important to note that lenders are more interested in your debt-to-income ratio than your income level. A lower debt-to-income ratio indicates a stronger financial position and improves your chances of mortgage approval.

Assets:

Assets play a significant role in the mortgage approval process, especially for those with non-traditional income sources or self-employed individuals. Assets can include liquid assets, such as cash in savings accounts, investments, retirement accounts, and proceeds from real estate investments. Lenders prefer liquid assets as they can be easily converted into cash if needed to cover mortgage payments. When assessing your assets, lenders will consider their value and whether you can sufficiently cover the monthly mortgage payments and any other debts you may have. Additionally, lenders may require you to verify and document your assets to ensure accuracy.

Asset Depletion Mortgages:

If you have significant assets but limited income, an asset depletion mortgage may be an option. This type of loan calculates your monthly "income" by dividing your total liquid assets by 360 months (the typical duration of a mortgage loan). This method allows you to prove that you have the financial means to cover the loan even without a regular employment income. However, it's important to note that asset depletion mortgage programs have varying guidelines, and it's essential to compare different lenders to find the best option for your needs.

Prequalification and Preapproval:

Before applying for a mortgage, you can choose to get prequalified or preapproved to gain a better understanding of your financial readiness. Prequalification provides an estimate of how much you can borrow based on a preliminary evaluation of your finances and a credit check. On the other hand, preapproval is a more comprehensive process where lenders verify your income, assets, and debts, and perform a credit check. A preapproval letter indicates that you are creditworthy and increases your chances of having your offer selected by sellers.

Frequently asked questions