What is a Mortgage Prequalification Letter?
Picture this: It’s Saturday, you’re out shopping for a house, and all of a sudden, you stumble upon your dream home. You have to have it.
But are you ready to make an offer?
If you want a shot at closing on the house of your dreams, you’ll need to have a prequalification letter from a mortgage lender. This post explores what a prequalification letter is and how to get one.
Prequalification Letters: Everything You Need to Know
Before we jump into our step-by-step instructions for getting a prequalification letter, it’s important that you know what prequalification is and whether or not you actually need it.
What is prequalification?
Prequalification is an initial screening done by a lender to determine that your basic financial information checks out. It’s a preliminary estimate that you’re someone a mortgage lender would consider lending to.
Suppose you’re interested in a new condo for $300,000 and have approximately 20% of the price saved as a down payment. During the prequalification screening, a lender will review your income, debt, and existing assets to calculate if you qualify for a mortgage loan of around $250,000.
If you pass the test, the lender will issue a prequalification letter, which you can then present to your real estate agent (or the seller’s). Realtors prefer buyers have a prequalification letter because it indicates the buyer is actually qualified to be shopping at a given price point. This is especially important in a competitive market, where several serious buyers might be interested in a single property.
Prequalification typically doesn’t cost anything, and the entire process only takes a few minutes to complete. You may even hear back from the lender that same day.
Another important aspect of a prequalification letter is that it typically indicates the interest rate you might qualify for on your mortgage. Again, it’s not an official loan offer—just a basic indicator that you’re clear to move on to the next phase of the borrowing process, which is preapproval.
Are prequalification letters mandatory?
You don’t have to get prequalified for a mortgage, but it’s recommended. It’s like getting VIP access to a concert or club. The bank is saying “you’re cool,” and letting you bypass the line.
It also shows your realtor and the seller that you’re a serious buyer, which can increase your chances of getting your offer approved.
How to Get a Prequalification Letter
Here’s a simple six-step guide to show you how to get a prequalification letter and what happens afterward.
- Find a lender
- Gather your basic financial documents
- Go through the application process
- Wait for a response
- Get preapproved
1. Find a lender
The first step is finding a lender. Chances are your realtor has someone they can recommend, so you may want to start by asking for a recommendation.
You don’t have to go overboard researching the lender. As long as the firm is well-established and recommended by your peers, you’re safe.
2. Gather your basic financial documents
Next, you have to provide some basic details like your income, debt, and assets. You may need to submit last year’s tax returns, pay stubs, or bank statements.
You’ll want to gather these documents early in the home-buying process anyway. There are a ton of documents you’ll need to submit as you move along, so the more organized you are upfront, the smoother things will go.
Another thing to keep in mind: the prequalification is only a preliminary estimate. Your lender is probably not going to take the time to manually verify the authenticity of each document you submit until you move on to preapproval.
With that said, make sure you’re as honest and accurate as possible with the data you provide. If there’s an error in your income or savings amounts, for example, this could significantly hinder your loan application.
3. Go through the application process
Lenders today let applicants apply either in person, online, or over the phone. Check with your lender ask about their process, then proceed with the option that makes sense for you.
4. Wait for a response
After you complete the prequalification process, wait for a response from the lender. It should come back the same day, and some lenders may even offer rapid-response prequalification.
5. Get preapproved
If you’re ready to move forward with making an offer, the next step is mortgage preapproval, which involves a more rigorous inspection of your finances.
Instead of just plugging in numbers, the bank will request a credit report (which requires a hard credit inquiry) and thoroughly investigate the information you disclosed during prequalification.
Here’s where it helps to have a good credit score and a low debt-to-income ratio. Also, keep in mind that some lenders charge an application fee at this stage, while others waive it or just apply the fee as a credit toward closing costs.
If you receive preapproval, congrats! You’re almost there. The final step is getting your application approved by a mortgage underwriter.
Key Factors Lenders Review During Prequalification
Here’s a breakdown of what a lender looks at when determining the home loan terms for which you prequalify.
One of the biggest factors a lender considers when issuing a prequalification letter is your credit score.
Your credit score is a current snapshot of your borrowing history, and it’s based on your overall credit history stretching back to the first bank account you ever opened.
Credit scores can vary depending on which credit bureau issues the score. Each bureau (Experian, Equifax, and TransUnion) has its own method of evaluating a borrower’s creditworthiness. Scores can range from 300 to 629 (bad), 630 to 689 (fair), 690 to 719 (good), and 720 to 850 (excellent).
Check your credit score by completing a credit check well in advance so you can make adjustments if needed and improve your score. If you need to pay off debt or make timely payments to improve your score, now’s the time!
Come to the table ready to tell a lender how much you make on an annual basis. This has the biggest influence on the loan amount for which you qualify.
It can get a bit trickier if your financial situation is more complicated. For example, independent contractors may have varying income levels. It can also get confusing if you invest heavily in the stock market or in real estate.
Do your research so you don’t wind up second-guessing yourself during the application.
The lender will want to see your debt-to-income ratio, which is how much debt you have compared to how much you’re bringing in. Debt may include different types of loans such as student loans, auto loans, existing mortgages, or credit cards, among other things.
As you might expect, lenders prefer borrowers with lower debt and higher income, and people in these situations usually receive lower interest rates as a result.
Principal, interest, taxes, and insurance (PITI)
The above factors reflect your overall personal financial situation. However, the lender will also factor in your target property’s specific costs to make sure you can afford it.
To do this, the lender will calculate principal, interest, taxes, and insurance (PITI) costs, which comprise your total monthly mortgage payment. Typically, lenders prefer your PITI costs are no more than 28% of your gross monthly income.
Frequently Asked Questions
What’s the difference between a prequalification and preapproval letter?
A prequalification is a preliminary, surface-level determination by a lender that you’re a qualified borrower. Getting prequalified comes before getting preapproved.
Preapproval requires going through a much more stringent financial review and is required to get a loan.
You don’t have to get prequalified but you must get preapproved to get a mortgage loan.
That said, prequalification typically benefits the homebuyer. Since it normally costs nothing, you can shop a prequalification letter around to various lenders for preapproval. A prequalification letter may also be required to view competitive properties.
Does prequalification check credit?
Yes, but it’s not a hard inquiry. During prequalification, lenders perform a soft credit pull. The lender will verify your credit, but it won’t stay on your credit history for years like a hard inquiry does.
How long do prequalification letters count?
Mortgage prequalification is typically good for a period of 90 days. After that, if you still don’t have preapproval, you may have to go through the process again to ensure your information is accurate and up to date.
Is mortgage prequalification worth it?
Talk to your real estate agent to determine if mortgage prequalification is worth it. Most agents encourage applicants to go forward with prequalification early in the process to see where they stand.
Getting prequalification from a mortgage broker can help determine the price range and mortgage options for which you’re eligible. It can also help the agent narrow down your criteria, saving time and resulting in a more efficient property search.
The Bottom Line
All first-time homebuyers should consider going through the prequalifying process during their home search. For most, it’s one of the first things you do when searching for a new home.
Prequalification is also one of the easiest steps during your mortgage application process because it just takes a few minutes.
Ultimately, buying a home is tedious and complicated. Yet this is by design. It’s supposed to weed out those who aren’t ready for the serious financial commitment of being a homeowner. If you find yourself tripping up during the prequalification process, it could be an indication that you’re not quite ready to step up to the plate.