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Why you need pre-approval letter

Published: Oct 14, 2009

"Trust but verify" was a popular expression in the Cold War, conveying the need to hold nations true to claims about their own nuclear arsenals. The same principle applies to you as a home buyer when you make claims about your ability to buy. To verify your status, you need a pre-approval letter.

A pre-approval letter verifies your ability to purchase a property. It is based on several factors including your credit score, job and employment history, current income, bank references, and the ability to fund your down payment. It does not specify numbers for each item, however. After all, you wouldn't want to advertise your bank account numbers or credit score to every seller or broker you encounter. But the letter verifies that a responsible lender has taken a good look into each area and drawn a conclusion about your home-buying ability.

Apply for a pre-approval letter and your lender will tell you exactly what information is needed. But a few items are certain to appear on the list, including:

  • Two years of tax returns complete with the W-2 forms verifying your income.

  • Your most recent pay stub, showing you're still employed.

  • At least two recent bank statements.

  • Verification of other sources of ongoing income such as alimony, child support, or a second job.

  • You'll also need a signed authorization for the lender to order your credit report, although for this, the bank will make it easy with a form for you to sign.

If you're applying online, you can expect to submit these items by fax. If you're visiting a lender in person, you'll save time by arriving with these items in tow. If the property purchase will be a joint affair (say among a husband and wife), you will obviously want documentation for both parties.

Obtaining a pre-approval letter may be instantaneous (particularly online), or it may take up to 48 hours, depending on bank bureaucracy.

Sellers and their agents see prospective buyers as faces on a totem pole.

At the bottom of the pole are those who make no attempt to establish their home-buying credentials. For them, home-shopping is kind of a sport. Brokers try to usher them out the door with just a handshake and a brochure.

A notch higher is where you'll find the pre-qualification crowd. The holders of "pre-qual" letters have at least walked into a bank or gone online and answered a few questions about their financial situation. But such letters require basically no verification. The idea is akin to the stated income mortgages of a few years ago, when false claims about their income and assets actually got a certain number of people into undeserved financing, called "liar loans."

Highest on the totem pole, where you should aim to be, is the pre-approval position. Here your assets, income, and debts are actually verified by the lender. But even a pre-approval letter is not binding. It is not a mortgage commitment or guarantee of credit. Banks know your situation might change between now and closing time.

Yet another reason for a pre-approval letter is that real estate agents have a sixth sense about who the serious buyers are. Some agents, in fact, won't deal with you at all without pre-approval. A pre-approval letter gives you leverage when negotiating with sellers. You as well will feel more confident knowing what you can borrow and buy.

The letter can be written in one of two ways. It can state the maximum purchase price you can afford, addressed "To Whom It May Concern." Or it can be addressed to a specific seller or his agent, stating your qualifications to pay a specific amount for the home. The latter approach is more personal and often more powerful, if it works. The former, clearly, is more useful in differing situations.

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