Home Buying Process
Mortgage prequalification is a way to estimate what you can afford. It indicates whether you meet the minimum requirements for a loan and how big of a loan you can get. It’s an important step to knowing whether or not you are financially ready to own a home. If you are confident with your finances or you have already been prequalified, then you may want to get preapproved instead.
What is Mortgage Prequalification?
Mortgage prequalification is how a lender will determine if you fit the basic financial criteria to get a home loan.
To get prequalified, you will give the lender some basic information about your debt, income, credit, and assets. This will give you a better understanding of how much you’ll be able to borrow. The information you give the lender for the prequalification process is self-reported. This means that the lender likely won’t be verifying your information or looking at your credit report.
What is the Prequalification Calculator?
Using a prequalification calculator can give you an idea of what to expect before talking to a lender. Some of the pieces of information you’ll need to provide include:
- Annual income before taxes
- Loan amount you’re interested in
- Interest rate for your mortgage type
- Credit score range
- Number of income sources
- Number of dependents
- Down payment amount
- Past forclosures or bankruptcy
- Monthly payments for existing debt
Understanding Debt-to-Income Ratio
The debt-to-income ratio, or DTI, is a formula that is commonly used by lenders for mortgage prequalification. It comes in two varieties: front-end and back-end.
- Front-end DTI is usually calculated as housing expenses such as monthly mortgage payments, property taxes, insurance, and any homeowners association fees, which is then divided by your gross monthly income.
- Back-end DTI is the sum of your housing expenses plus all of your other monthly debt. This includes credit cards, personal loans, student loans, and car loans. This is then divided by your gross monthly income.
Most conventional mortgage lenders prefer a back-end DTI of 36% or less. However, government-backed loan programs sometimes allow a higher percentage amount.
Prequalification vs. Preapproval
When you prequalify, you are “telling” the lender your information, it is not being verified. For a preapproval, you will need to provide proof of your income, debt, assets, and credit score.
To get preapproved, you will need to provide documentation like pay stubs, proof of assets, and tax records. Verifying your financial information may take a few days. Once it goes through, your lender should supply you with a preapproval letter which you’ll be able to show your real estate agent or seller so that you can show proof that you’re ready and able to purchase a home.
Remember, prequalification does not guarantee preapproval. If your financial documentation do not support the numbers you reported, you can still be turned down for a loan.