“What is Mortgage Preapproval?”
And why to get one BEFORE you start looking
Written By: Mariko Baerg, REALTOR of Bridgewell Real Estate Group
If you’re looking for a realtor to help you buy or sell, contact our team today!
If you’re thinking of buying a home, you’ve likely heard of the term mortgage preapproval.
We get asked all the time: “What is a mortgage preapproval?” So we’ve put together a blog to answer the question.
This blog also provides information on the difference between prequalification & preapproval, documentation needed for approval, and the benefits of this important step when buying a home.
What is mortgage preapproval?
A mortgage preapproval can essentially be seen as a physical exam of your finances, which will help you to determine your affordability when applying for a mortgage.
You will submit documents to the lender, and before they decide to preapprove you for a mortgage they will also look at a number of key factors to your financial history such as:
- Your credit history
- Credit score
- Debt-to-income ratio
- Employment history
- Income
- Assets and liabilities
As a borrower, it’s important to know that a mortgage preapproval is a multi-step process that involves reviewing your income first but also the lender approving the property second.
Even if you are preapproved for $500,000, if upon receiving an accepted offer the lender isn’t satisfied with the property documents (i.e. the depreciation report) then they can still deny financing. This is why the preapproval process is not an official approval, and can also be used interchangeably as a prequalification.
Pre-qualified or pre-approved — what’s the key difference?
Mortgage pre-qualification is generally a quick, simple process in which the mortgage broker or bank representative reviews your basic financial information. This will include how much you make a year, and potentially debt and assets, and is essentially them looking at a general overview of your affordability.
The representative will then give you an estimate as to what they expect the lender would be willing to lend towards your home purchase. You’ll often see these offered online, or quickly at a bank branch in less than 5 minutes. This is not a guaranteed loan and does not typically take a deep dive in to all of your financial history, income history, or credit score.
Mortgage pre-approval is a more formal and significant milestone in the home buying process because a lender is actually checking your credit and verifying your financial information.
If you’re pre-approved, a representative has done a deep dive in to all of your documentation and provided them to the lender. HOWEVER, preapproval is still a form of prequalification (and thus can be used interchangeably), as the lender still needs to review the property details, strata documents (if strata) and confirm property valuation via an appraisal for them to officially commit to providing you a loan to purchase.
Pre-approval is not necessarily a guarantee that you will receive a specific rate or mortgage from that lender because circumstances may change from the time you get-preapproved until the time you’re ready to make a purchase.
Why get a mortgage preapproval?
Talking to a mortgage representative BEFORE you start your home buying process has so many benefits, and will guaranteed make the process easier, less stressful, and more straight-forward for you.
Here are some of the benefits of getting a mortgage preapproval when buying a home:
- You’ll know exactly how much you can afford from the get go, which means you’ll save time house-hunting! Plenty of people make the mistake of falling in love with a home after months of searching, only to find out that they can’t afford it. Getting preapproved from the start will mean you have a clear path to success.
- You will have a better idea of what your monthly mortgage payment will look like, as well as how much down payment you will need. If you’re thinking of putting more or less down, you’ll also be able to run different down payment scenarios with your mortgage broker to determine what the best down payment to mortgage payment ratio is for you.
- Your real estate agent will be able to better serve if they know what your affordability is.
- When you make an offer to purchase, home sellers are more likely to work with you when you’ve done a prequalification/preapproval because they’ll know that you’re a ready and able buyer.
- Your preapproved status may give you more negotiating power with a seller when compared to a buyer that is not preapproved.
- You’ll be able to lock in a rate (typically for 90-120 days) so that you don’t have to worry about rising interest rates. This means that the lender will honour the locked in rate at the time of your preapproval, even if the rate at your time of purchase is higher.
- There’s no cost to you and you’re not obligated to accept the mortgage. It’s simply knowledge for you to prepare for your home purchase, and knowledge is power!
Why do I need a subject to financing clause if I already have a mortgage pre-qualification or pre-approval?
The mortgage preapproval is still a qualification in itself, as it is a two step process that involves: #1 – your income & financial review #2 – the property review
Because step #2 cannot be done until you have an accepted offer in place, this is why it is still incredibly important to have a subject to financing clause in your contract of purchase and sale.
This is also why it is very important to have your mortgage broker and your realtor working closely together as a team. Your realtor will need to provide a number of documents to your mortgage broker upon you receiving an accepted offer, and will likely need to communicate with the broker in the event that the lender has any questions about the property.
During the subject removal process to obtain your final preapproval for the mortgage, the lender will also require the following regarding the property:
- Accepted offer
- Property disclosure statement filled out by the seller
- Appraisal to confirm property valuation
If this is a strata property, they will also often require:
- Last 2 years of all strata minutes (annual, general & special meetings)
- Depreciation report
- Engineering report
- Form B document and strata financials
Having the subject to financing is especially important for the strata properties, as the strata documents can often be hundreds of pages in length. A lot of questions can come out of the strata documents, specifically the depreciation report.
You will want to keep yourself protected from losing your deposit by making sure that you do not remove the subject to financing until the lender has given you a commitment to a mortgage on the property.
The contract, subject removal, and legal side of real estate are all complex, so you’ll want to make sure that you are working with a realtor that is familiar and experienced in contract writing. At Bridgewell, we have the experience you need – Mariko even teaches other realtors how to write contracts! If you’re looking for an experienced realtor to help you with your home purchase, call Bridgewell today: 604-319-0200
What documents will I need for a mortgage preapproval?
The preapproval process requires a deep dive in to your financials, and with that comes a lot of required documentation and paperwork! It is best to give yourself about a week to complete this part of the process.
A mortgage broker will need a number of documents from you, most notably the following:
- often require 60 days of bank statements
- often require 30 days of paystubs
- tax returns from the previous two years
- additional tax documents for self-employed borrowers (i.e. profit/loss statement, balance sheets, bank statements, business license, federal returns)
- income tax returns
- asset account statements (retirement savings, stocks, bonds, mutual funds, etc.)
- driver’s license or passport
- divorce papers, if applicable (to use alimony or child support as qualifying income)
- often require a job letter
- gift letter (if funding your down payment with a financial gift from a relative)
- approval to pull credit score
Down Payment Gifts for Mortgage Preapproval Rules
It is common – especially if you are a first time home buyer – to be gifting money from a relative to go towards your down payment.
If you do go this route, make sure that you are aware that a lender will ask you to complete a standard gift letter in which you and the donor will need to confirm that the down payment gift does not have an expectation of repayment and is not a loan. Additionally, both you and the donor will have to provide bank statements to source the transfer of cash funds from one account to another and it sometimes needs to be in your account for a minimum period of time (i.e 60 days).
The reason why a lender requires a gift letter is because they need to make sure your down payment is not a debt. If this were the case, they would need to factor it in to your debt-to-income ratio, which would impact the affordability of your final loan approval.
Credit History and Score
An important part of the mortgage preapproval process is the representative pulling your credit history and score. If your credit score is good, you’ll likely be able to work with a bank or “A” lender which will often provide you with a better interest rate. The purpose of pulling your credit score is for the lender to look at your payment history and see whether you have paid your bills on time, how many and how much debt you’re currently carrying, and the length of time you’ve had the credit accounts. They’ll also look in to your spending history to see how much credit you actively use, and whether you have a responsible, consistent pattern or are not managing your debt wisely.
If you are thinking of purchasing a home but have not opened any credit cards, lines of credit, or a loan (i.e. student, auto), then it may be a good idea for you to start building your credit by opening a starter card. It could take up to six months for your payment activity to be reflected in your credit score, so as a part of your home purchase planning process this is a great first step. You’ll also learn the habit of paying off your bill each month and tracking your spending!
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If you’re looking to hire a realtor with experience to help guide you through the process of buying a home, then reach out to us today at [email protected] or 604-319-2020 for realtor representation!
