Mortgage pre-approval: a guide for first-time homebuyers

Buying your first home comes with plenty of new terms, and two you’ll probably hear early on are pre-qualification and pre-approval. They’re not the same thing.

Pre-qualification gives you an early estimate of what you may be able to borrow based on basic financial information you provide. Pre-approval takes a closer look at your finances and can give you a clearer idea of your potential loan amount when you’re ready to start shopping.

Knowing the difference can help you decide when to take each step, what documents to have ready and how your income and monthly debts factor into your homebuying budget.

Key takeaways:

• Pre-qualification is an early estimate based largely on financial information you provide.
• Pre-approval involves a mortgage application and review of financial documentation.
• A pre-approval letter can show sellers you’ve taken steps toward securing financing.
• You’ll typically need documents showing your income, assets and other financial information for pre-approval.
• Your debt-to-income ratio, or DTI, is one factor lenders consider when evaluating your mortgage application.

The simplest way to think about it is that pre-qualification helps you explore, while pre-approval helps you prepare to shop.

Pre-qualification is generally an informal first look at your finances. You provide basic information about your income and debts to get a better understanding of how much you may be able to borrow. Try out our pre-qualification calculator to get an estimate.

Pre-approval goes further. You complete a mortgage application and provide financial documentation for review. If you meet the lender’s requirements, you can receive a conditional pre-approval letter showing the loan amount you may qualify for.

To be clear, neither one is a final mortgage approval. Your loan will still need to meet applicable underwriting, property and program requirements before closing.

If you’re just starting to think about buying a home, pre-qualification can give you an early idea of what may fit your budget. Once you’re serious about shopping, pre-approval is the more useful next step. Your lender will take a closer look at your finances and, if you meet applicable requirements, provide a conditional pre-approval showing the loan amount you may qualify for.

A pre-approval letter can also show sellers and their agents that you’ve already taken steps toward obtaining mortgage financing.

You don’t have to get pre-qualified first. If you’re financially prepared and ready to start shopping, you may choose to move directly to pre-approval.

Having your financial documents ready can make the pre-approval application process easier and help prevent unnecessary delays.

Requirements vary based on your financial situation and loan program, but you may be asked for:

• Proof of income: Recent pay stubs, W-2s or other income documentation
• Tax information: Tax returns may be requested, particularly if you’re self-employed or have income that requires additional documentation
• Bank and asset statements: Recent statements for checking, savings, investment or other applicable accounts
• Identification: Government-issued identification and other identifying information
• Employment information: Current employer and employment history
• Debt information: Information about outstanding loans, credit cards or other monthly debt obligations
• Additional documentation: Records related to gifts, additional income or other financial circumstances, if applicable

Your loan officer can provide a personalized list based on your loan program, employment and financial situation.

Your debt-to-income ratio, usually called DTI, compares your monthly debt payments with your gross monthly income, or what you earn before taxes and other deductions.

Lenders use DTI as one way to understand how much of your income is already committed to debt and how a potential mortgage payment could fit into your finances.

The calculation is: Total monthly debt payments ÷ gross monthly income × 100 = DTI

For example, say you earn $6,000 per month before taxes and have the following monthly debts:

• Car payment: $400
• Student loan payment: $250
• Minimum credit card payments: $150
• Estimated monthly housing payment: $1,600

Your total monthly debt payments would be: $400 + $250 + $150 + $1,600 = $2,400

Then calculate your DTI: $2,400 ÷ $6,000 × 100 = 40 percent

In this example, your DTI would be 40 percent, meaning 40 percent of your gross monthly income would go toward the debts included in the calculation.

There isn’t one DTI limit that applies to every mortgage. Requirements vary based on the loan program, borrower qualifications and other factors considered during underwriting.

Your pre-approved loan amount can give you a useful starting point for your home search, but it doesn’t have to become your homebuying budget.

Think about the complete cost of owning the home, including expenses such as:

• Principal and interest
• Property taxes
• Homeowners insurance
• HOA fees, if applicable
• Utilities
• Maintenance and repairs

You’ll also want to plan for upfront expenses such as your down payment, closing costs and moving costs. Finding a price range that fits comfortably within your overall budget can be just as important as knowing the maximum amount you may qualify to borrow.

If you’re still exploring your budget, pre-qualification can give you an early idea of what may be possible. Once you’re ready to seriously shop, pre-approval can provide a clearer picture of your financing and help you prepare to make an offer.

A Guild loan officer can help you understand both steps, review your finances and answer questions about your homebuying budget. When you’re ready, getting pre-approved can help you start your home search with a better idea of what you can afford and what comes next.