Are you planning to use an FHA loan to buy a house? If so, it’s probably a good idea to get pre-approved by a lender. It will help you identify your price range, and will make sellers more inclined to accept your offer.
This article explains how the FHA pre-approval process works, and why it’s worth pursuing in the first place. But first, a basic definition…
Pre-approval is when the mortgage lender evaluates your financial situation. They use this process to determine whether or not you are qualified for a home loan. They also do it to determine how much money they are willing to lend you. Obviously, these two decisions are very important to you. You can get pre-approved for any type of mortgage loan. In this article, we will focus on FHA pre-approval in particular.
How FHA Mortgage Pre-Approval Works
Questions to answer: How does the pre-approval process work? What does the lender look at when you apply for a loan? And what kind of documents do you need to provide?
This process has a “pre” attached to it because it happens before you’ve found a home. Later on, when you’ve found a house and made an offer to buy it, you’ll go back to your lender for the actual approval. So you can think of it as a two-part approval process for an FHA loan.
When you get pre-approved by a lender, every aspect of your financial situation will be scrutinized and analyzed:
- Credit: They will check your credit score to see if you meet their minimum guidelines. For an FHA loan, the credit score cutoff could be as low as 500 (though some lenders require a 600 or higher).
- Earnings: Income verification is another important part of the FHA pre-approval process. Here, the lender wants to know how much money you earn each month. They can learn this by looking at your tax returns for the last couple of years, as well as your pay stubs for the last few months. It’s not enough to say how much you earn. The lender will want to see proof of income when you get pre-approved for an FHA loan.
- Debt: Your income is important by itself. But the lender will also compare your income to the amount of debt you have. This is referred to as your debt-to-income (DTI) ratio. It’s a comparison between the amount of money you make each month, and the amount you spend to cover your various debts. A lower DTI is better. If you’ll end up spending more than 45% of your income on your monthly debts (mortgage payment included), you might have trouble getting approved for a loan. But this number is not set in stone.
- Assets: During the FHA pre-approval process, the lender will also review your assets. This includes a savings account, 401K, stock dividends, etc. They want to know how much money you have at your disposal. You’ll need sufficient funds in your savings account to cover the down payment and closing costs, at a minimum. Some lenders may have additional cash-reserve requirements as well. It varies.
Commonly Requested Documents
I mentioned some of the documents you’ll need to get pre-approved. Here’s a more complete list. At some point during this process, you will probably need to provide the following items:
- Social Security card
- W-2 statements and tax returns for the last two years
- Pay stubs for the last two months (showing year-to-date earnings)
- Employment verification letter
- Divorce decree if applicable
- Documents relating to your other assets
This is a short list of the most commonly requested items. Your lender might ask for additional documents to complete the FHA pre-approval process.
After the lender reviews all of this information, they will tell you two things: (1) You’ll find out if you qualify for a mortgage loan, based on your current financial situation. (2) You’ll also find out how much they are willing to lend to you. Just understand that this is not a guarantee. Things can still go wrong after the home loan pre-approval. So your goal is to stay qualified, all the way through to closing.
Isn’t Pre-Qualification Just as Good?
No. FHA “pre-qualification” is not as helpful as pre-approval. A lender can pre-qualify you for a loan based solely on what you tell them. You can tell them you have this much income and that much debt. You can tell them you have pretty good credit. You can even answer these questions online, through the lender’s website. But there is very little verification during the pre-qualification process. It’s more like a conversation starter than a financial review.
The FHA pre-approval process goes further by verifying and scrutinizing your finances. Because of this, the lender can give you a more accurate picture of your borrowing power. They’ll also give you a letter that shows you’ve been pre-approved. This letter will make sellers more inclined to accept your offer, since it’s a form of vetting.