Before you submit a real estate offer, you should be already preapproved for a mortgage.
During good times, being a preapproved buyer improves your odds of beating out other competing offers.
During bad times, like during a global pandemic where everyone craves certainty, being preapproved greatly improves your odds of getting a good deal.
Let me share with you the process for getting preapproved; what documents you will need to get preapproved; and why being preapproved for a mortgage is so important.
But first, let me explain the difference between prequalified versus preapproved. These terms are sometimes used interchangeably, which is incorrect.
The Difference Between Preapproved And Prequalified
Prequalification is good, but it is not nearly as good as getting preapproved. When you prequalify for a home loan, you’re getting an estimate of what you might be able to borrow, based on information you provide about your finances, as well as a credit check.
Consider prequalification more like dating. You and the bank are still trying to get to know each other, but you’re not 100% serious yet. The lender has not fully committed to supporting you if you buy a home. You can use the prequalification process to figure out whether you want an adjustable rate mortgage or a fixed-rated mortgage.
Preapproval is as close as you can get to confirming your creditworthiness without having a purchase contract in place. You will complete a mortgage application and the lender will verify the information you provide. They’ll also perform a credit check.
If you’re preapproved, you’ll receive a preapproval letter, which is an offer to lend you a specific amount, usually good for 90 days. Once the 90 days is over, you have to go through the preapproval process again if you still haven’t found a home.
Consider preapproval more like getting engaged. You are 95% committed to each other and plan on getting married. But unlike getting engaged, you don’t have to buy a costly engagement ring. Getting prequalified or preapproved is usually free.
In both cases, the mortgage rate you get will also be an estimate until you get into contract and lock.
How To Get Preapproved For A Mortgage
The very first thing you need to do is find a reputable lender. You can do so by either finding one online or you can reach out to an existing banking relationship.
Because I recently refinanced my primary home mortgage, I reached out to the same lender to see if they were open to doing purchase loans. With refinancing demand sky-high due to record-low interest rates, not all lenders have the capacity to take on purchase loans.
However, as during normal times, most lenders usually prioritize purchase loans over refinances. Therefore, my lender said he was willing to work with me.
What The Lender Will Want To Know
Timing: The lender will want to know approximately when you plan to buy. Ideally, you want to get preapproved one day before you find that ideal property because preapproval won’t last forever.
After two or three months, you will have to resubmit financial documents. You also don’t want to get preapproved more than two weeks after a property first lists, because your competitors will have had more time to put in a better offer.
Price: The lender will want to know the approximate price range of the property. If you have a specific property in mind, you can send him or her the listing. It’s important to get approval for the maximum property price.
It’s much easier to change the terms and get preapproved for less money than more money. If you decide you need more money, you may have to go through a time-consuming underwriting process again.
Getting permission to do a credit check: To get preapproved or prequalified, the lender needs to check your credit. The credit check usually shouldn’t cost you anything and usually shouldn’t hurt your credit score, unless you’ve had multiple credit checks within the last couple of months.
Plans for existing residence: The lender will want to know what you plan to do with your existing residence. Sell or rent it out are the two usual options. But other options could include leaving the property empty, turning the property into a home office, or letting a friend or relative live on the property rent-free.
Duration at existing residence: If you refinanced your primary residence within the past 12 months and plan to get a purchase mortgage with the same lender, you may hit an underwriting road bump.
The reason why is because most primary mortgage refinances require the homeowner to sign-off that he or she plans to live in the home for the next 12 months. This agreement helps protect the bank from property owners who try and refinance rental properties or properties earmarked for rental as a primary residence. Mortgage rates for primary residences are often 0.25% – 0.75% lower than mortgages for rental properties.
If you go with a lender who did not refinance your existing primary mortgage within the past 12 months, you may not have to go through any delays due to further underwriting scrutiny.
Documents Needed To Get Preapproved For A Mortgage
Here are the documents your lender will likely ask from you to get preapproved:
- Two most recent paystubs (months)
- Two most recent W2s (years)
- Two most recent 1099s if applicable (years)
- Two most recent tax returns (years)
- Two most recent investment statements (months)
- Two most recent checking and savings account statements (months)
- Latest business profile and loss statement and balance sheet if applicable
- Mortgage and HOA statements for all investment and vacation properties
- An explanation for all large (over $1,000) banking transfers and deposits during the last two months
- Printouts of large (over $1,000) check deposits during the last two months
In addition to requiring plenty of financial documentation, your lender may also want you to write a short note stating why you want to buy. If you purchased another property or refinanced your primary mortgage within the past 12 months, the lender will more than likely ask you to explain your actions.
A short explanatory note can either be done in an e-mail or in a word document. Here’s an example:
I’d like to get preapproved for a mortgage because I’m looking to take advantage of potential real estate deals during a pandemic. Never in my wildest dreams did I expect a virus to derail the entire economy and lock us up for months. We are a family of four looking for more living space and a backyard.
We have enough cash to put down between 20% – 60%. Ideally, we’d like to take advantage of low mortgage rates and put down somewhere between 20% – 30%, depending on the results of your underwriting process. As you can see from our credit report, we are excellent borrowers who take our obligations seriously.
A Financial Samurai
Why Getting Preapproved Is Critical
The more you can get your finances in order before a large purchase, the better your experience will be. Don’t wing one of the largest purchases in your lifetime!
To get the best price and have the best chance of winning, it’s always best if you can make a true all-cash offer.
So many things can and will go wrong during a real estate transaction. Therefore, if you have an all-cash offer, you remove one of the most frequent causes of a broken contract: a financing contingency.
A financing contingency gives a buyer a risk-free exit if he doesn’t get approved for a mortgage or doesn’t like the terms of his mortgage. In this situation, the seller’s successful sale is dependent upon both the buyer’s price decision as well as the lender’s.
If you do not have the funds to pay all cash for a home, then the next best thing is to get preapproved for a mortgage before submitting an offer. Given you already have preapproval, as a buyer, you can confidently submit a no-financing contingency offer.
From the seller’s perspective, having a no-financing contingency offer should drastically reduce his concern that the deal will fall through. While there may still be some concern given two buying parties are involved instead of just one, however, there could also be more confidence in the deal going through because a reputable lender usually has way more money than any individual.
Some sellers view a no-financing contingency as good as a true all-cash offer. Of course, in addition to having no-financing contingency, a buyer can also sweeten his offer by waiving an inspection and having a fast close.
With a true all-cash offer, the fastest closing time is usually between 10 – 14 days. With a no-financing contingency offer, the fastest time to close is usually about 21 days. Either way, closing in 10 – 21 still compares favorably to 46 days, the average time it takes to close on a new home purchase according to Fannie Mae.
One Timing Caveat For A Preapproved Offer
In an ideal scenario, you will be fully preapproved before making an offer on a property. However, sometimes during your preapproval qualification process, you may find a property that you absolutely love. If you find yourself in this scenario, you will likely have to make an offer with a financing contingency.
You can always gamble and still make a no-financing contingency offer if you are supremely confident your lender will come through or if you have enough funds to make up any shortfall. Just be aware that backing out of a deal due to financial reasons when you did not have a financing contingency puts you at risk of losing any earnest money you put down – usually 3% of the purchase price. Further, you won’t have the preapproval from the lender to give the seller extra confidence.
When it comes to buying real estate, financial preparation is key. Get preapproved for a mortgage so you can better compete. And if you still don’t understand why mortgage preapproval is so important, then put yourself in the seller’s shoes.
Having a great offer with a lovely real estate love letter is nice. But without preapproved financing, it’s much harder to take a risk and accept that offer when there is another buyer who is 100% ready to go.
Looking for a lender? Find one on Credible, one of the best lending marketplaces where qualified lenders compete for your business. Not only do you want a lender to get you preapproved, you also want the lender to offer the lowest interest rate possible. Mortgage rates are at all-time lows. Take advantage.