Home loan approval: What it takes

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In a Nutshell

Understanding the home loan approval process can prepare you to apply for a mortgage. The home loan approval process may vary depending on the type of loan you want.
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Whether you’re a first-time homebuyer, downsizing in retirement or somewhere in between, getting approved for a mortgage takes time.

For that reason, it’s a good idea to begin preparing for the home loan approval well in advance — maybe even a year ahead of time, in some cases — for best results.

To help you prepare, we’ll go over the process of applying for a home loan and what it takes to get approved.



Loan approval, preapproval and prequalification

Though you might hear the terms “prequalified” and “preapproved” used interchangeably, they generally have different meanings when it comes to mortgages — though neither actually refers to full loan approval. So let’s understand exactly what each of those terms typically means.

Prequalification

Prequalification is usually one of the first steps in the homebuying process. When you get prequalified for a home loan, you’re essentially getting an estimate of what you may be able to borrow. You get this by providing some basic information about your finances to the lender and allowing it to check your credit.

After getting prequalified, you can begin shopping for a home with a better idea of how much home you can afford.

Preapproval

Getting preapproved for a home loan takes the prequalification a step further. For preapproval, you complete a mortgage application, and the lender verifies information on your application by running your credit and reviewing your pay stubs, bank statements, tax returns and other documents.

Once you’ve been preapproved, the lender will issue a preapproval letter, which is essentially an offer to lend you a certain amount. But preapproval isn’t a firm commitment to issue a loan. If your credit drops significantly or your financial situation changes before final loan approval, you may not be able to get the mortgage.

Loan approval basics

When deciding whether to approve your mortgage application and what loan terms to offer, lenders look at several factors, including the following.

Qualifying income

Lenders want to know that you have enough income to cover your mortgage payment as well as other regular living expenses and debt payments, but not all income counts in their determination. Here are some of the sources of income that lenders may count.

  • Salary and wages
  • Overtime that meets lender requirements
  • Commissions that meet lender requirements
  • Income from self-employment or a business you own
  • Interest and dividend income
  • Social Security benefits
  • Income from a rental property
  • Alimony and child support payments

Dependable payment history

Lenders review your credit reports and credit scores, in part, to determine whether you’re likely to make your monthly mortgage payments on time.

FICO® scores

When lenders run your credit, they typically request a credit report from each of the three major credit bureaus (Equifax, Experian and TransUnion), plus the FICO credit scores for those reports. Each lender or mortgage program has its own minimum credit score requirements, but conventional loans usually require a FICO score of at least 620.

No delinquent accounts at the time of your application

Currently delinquent accounts on your credit reports can seriously drag down your credit scores and make it harder to get loan approval. While some lenders may be willing to approve your application, they may charge you a higher interest rate or require you to make a larger down payment.

Acceptable debt-to-income ratio

Your debt-to-income ratio is the percentage of your gross monthly income that goes toward outgoing debt, including your mortgage payment. DTI requirements vary by lender.

Loan approval guidelines will vary

When you’re shopping around for a mortgage, you have many options to choose from, and each lender and loan program has different approval guidelines. Here are a few common types of home loans and an overview of the requirements for each.

VA loans

The U.S. Department of Veterans Affairs backs VA loans, which aren’t available to the general public — only to eligible veterans, active military members and certain qualifying surviving spouses of military members who died as a result of military service.

VA loans don’t have a VA-defined minimum credit score, but you must have a Certificate of Eligibility from the VA to prove to your lender that you qualify based on your service history and status.

FHA loans

FHA loans are backed by the Federal Housing Association, which is a part of the U.S. Department of Housing and Urban Development.

The minimum credit score for an FHA loan varies by lender, but can’t be less than 500, according to HUD rules.

USDA loans

The U.S. Department of Agriculture backs mortgages for borrowers interested in buying homes in rural areas.

USDA loans don’t have minimum credit score requirements, but they do have income limitations, which vary by location.

Construction loans

If you need financing to build a home, a construction loan can help you cover the cost of buying land (if needed) and building the house.

If you want to act as your own contractor, discuss this with a loan officer — your financial institution may not permit you to do so. As part of the loan approval process, the lender will review your contractor’s experience, reputation, credit and licenses to ensure the contractor can get the job done on time and within a reasonable budget.

Condo loans

Many lenders, including participating FHA lenders, offer home loans to purchase a condominium unit. Getting approved for a condo loan is similar to getting approved for a mortgage on a single-family house. But to use an FHA loan to buy a condo, the project has to meet HUD’s eligibility requirements and be included on or added to the FHA’s approved condominium project list. Conventional condo loan requirements may vary depending on the lender.

How to prepare for home loan approval

Applying for a mortgage is never simple, but it’s even trickier when you’re not prepared. To make the loan approval process easier on yourself, give yourself plenty of time to get your finances in order.

  1. Check your credit reports and credit scores. Ensure there aren’t any errors dragging your scores down. If you do find inaccuracies, dispute them with the credit bureaus. Disputes can take 30 days — or longer — to resolve, depending on your circumstances, so start this process early.
  2. Improve your DTI ratio. You’ll be able to qualify for a larger mortgage if you earn more money or pay off other debts before applying.
  3. Save up for your down payment and closing costs. You may qualify for a mortgage with a small down payment, but a larger down payment reduces your principal balance on the loan, saving you money over the term of the mortgage. Closing costs are the expenses you pay in cash on closing day (not included in the loan amount) and you’ll need to save up for those as well.
  4. Gather your paperwork. To save time, it’s a smart idea to start gathering the documents you’ll need to apply for a mortgage. Most lenders want to see pay stubs for the past month, W-2s and tax returns for the past two years, a few months’ worth of bank statements, and recent statements from other loans and asset accounts.

What’s next?

Nothing can guarantee that your loan approval process will go smoothly, but the better prepared you are, the easier it should be to get the mortgage you need to buy the home you want. You can begin by checking your credit to see what steps you might need to take next.


About the author: Janet Berry-Johnson is a freelance writer with a background in accounting and insurance. She has a bachelor’s degree in accounting from Morrison University. Her writing has appeared in Capitalist Review, Chase News &a… Read more.