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Michele Lerner has 25+ years of experience as a freelance journalist. She was the winner of The President’s Gold Award for Best Freelance Collection.
Updated August 26, 2024 Reviewed by Reviewed by Lea D. UraduLea Uradu, J.D. is a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, and Tax Writer.
Part of the Series When to Buy a Home Based on Mortgage RatesHow Mortgages Work
Rates for Different Loan Types
Best Mortgage Rates
Lender vs. Broker
Most sellers expect buyers to obtain pre-approval for financing and are commonly willing to negotiate only with those who prove they can get a loan. Pre-approval in this context is more meaningful than in other situations—such as credit card offers—when the term is used. In this case, it means a lender has verified the buyer's qualifications and that the pre-approval is good for two or three months.
The key things necessary for pre-approval are proof of income and assets, good credit, verifiable employment, and documentation necessary for a lender to run a credit check.
A mortgage pre-qualification can be useful as an estimate of how much someone can afford to spend on a home, but a pre-approval, often valid for 60 to 90 days, is more valuable. It means the lender has checked the buyer's credit, verified assets, and confirmed employment to approve a specific loan amount.
Buyers benefit by consulting with a lender, obtaining a pre-approval letter, and discussing loan options and budgeting. The lender will provide the maximum loan amount, which will help set the price range for the home shopper. A mortgage calculator can help buyers estimate costs.
Mortgage pre-approval requires a buyer to complete a mortgage application and provide proof of assets, confirmation of income, good credit, employment verification, and important documentation.
Pre-approval is based on the buyer's FICO credit score, debt-to-income ratio (DTI), and other factors, depending on the type of loan.
Except for jumbo loans, all loans conform to Fannie Mae and Freddie Mac guidelines. Some loans are designed for low- to moderate-income homebuyers or first-time buyers. Others such as Veterans Affairs (VA) loans, which require no money down, are for U.S. veterans and service members.
Upfront fees on Fannie Mae and Freddie Mac home loans changed in May 2023. Fees were increased for homebuyers with higher credit scores, such as 740 or higher, while they were decreased for homebuyers with lower credit scores, such as those below 640. Another change: Your down payment will influence what your fee is. The higher your down payment, the lower your fees, though it will still depend on your credit score. Fannie Mae provides the Loan-Level Price Adjustments on its website.
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Potential homebuyers must provide W-2 wage statements and tax returns from the past two years, current pay stubs that show income and year-to-date income, and proof of additional income sources such as alimony or bonuses.
A borrower's bank and investment account statements prove that they have funds for a required down payment, closing costs, and cash reserves. The down payment, expressed as a percentage of the selling price, varies by loan type. Many loans require the buyer to purchase private mortgage insurance (PMI) if they are not putting down at least 20% of the purchase price.
Most lenders require a FICO score of 620 or higher to approve a conventional loan or 580 for a Federal Housing Administration loan. Lenders typically reserve the lowest interest rates for customers with a credit score of 760 or higher.
The chart below shows a monthly principal and interest payment on a 30-year fixed interest rate mortgage based on a range of FICO scores for three common loan amounts. An interest rate tool from the Consumer Financial Protection Bureau lets buyers see how credit score, loan type, home price, and down payment amount can affect the interest rate.
On a $250,000 loan, an individual with a FICO score in the lowest (620–639) range would pay $1,879 per month, while a homeowner in the highest (760–850) range would pay just $1,607, a difference of $3,264 per year.
FICO Score Range | 620-639 | 640-659 | 660-679 | 680-699 | 700-759 | 760-850 |
|---|---|---|---|---|---|---|
Interest Rate* | 8.254% | 7.708% | 7.278% | 7.064% | 6.887% | 6.665% |
$350,000 loan | $2,630 | $2,497 | $2,394 | $2,344 | $2,302 | $2,250 |
$250,000 loan | $1,879 | $1,784 | $1,710 | $1,674 | $1,644 | $1,607 |
$150,000 loan | $1,127 | $1,070 | $1,026 | $1,004 | $987 | $964 |
Lenders not only verify employment through a buyer's pay stubs but will likely call the employer to confirm a borrower's employment and salary.
Self-employed buyers provide additional information such as the stability of the borrower’s income, the location and nature of the business, the financial strength of the business, and the ability of the business to continue generating and distributing sufficient income to enable the borrower to make the payments on the mortgage.
Personal documents and identification required for pre-approval include the borrower's driver's license, Social Security number, and authorization to allow the lender to pull a credit report.
A lender is required to provide a document called a loan estimate within three business days of receiving a completed mortgage application. It outlines the pre-approved loan amount and maximum loan amount, terms and type of mortgage, interest rate, estimated interest and payments, estimated closing costs, an estimate of property taxes, and homeowner’s insurance.
The loan file will eventually transfer to a loan underwriter who will also ensure that the borrower meets the guidelines for the specific loan program to determine full approval. If nothing has changed in the buyer's financial situation since pre-approval, the buyer and lender can then move forward with the closing of the loan. Final loan approval occurs when the buyer has an appraisal completed for the home and the loan is applied to the property.
After reviewing a mortgage application, a lender will provide a decision to pre-approve, deny, or pre-approve with conditions. These conditions may require the borrower to provide extra documentation or reduce existing debt to meet the lending guidelines. If denied, the lender should explain and offer options to improve a borrower's chances for pre-approval.
Getting pre-approved for a mortgage is best before you start looking for houses as it helps determine a maximum loan approval amount. Pre-approval also determines obstacles like excessive debt or poor credit scores.
Getting pre-approved for a mortgage gives a home buyer bargaining power since they already have mortgage financing and can therefore make a reasonable offer to the seller of a home in which they are interested. Otherwise, the prospective buyer would have to apply for a mortgage before making an offer and potentially lose the opportunity to bid on a home.
The loan-to-value (LTV) ratio is an assessment of lending risk that financial institutions and other lenders examine before approving a mortgage and compares the loan value to the market value of the property. Typically, loan assessments with high LTV ratios are considered higher-risk loans. Therefore, if the mortgage is approved, the loan has a higher interest rate.
The debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes to paying your monthly debt payments and is used by lenders to determine your borrowing risk.
Mortgage pre-approval is an examination of a home buyer's finances and lenders require five items to ensure borrowers will repay their loan. Potential borrowers complete a mortgage application and provide proof of assets, confirmation of income, credit report, employment verification, and important documentation to obtain pre-approval.
