Prequalification is the term given to an informal evaluation of your worthiness as a borrower for a mortgage/loan. During prequalification, your potential lender will take into account how much you can afford to repay each month. Prequalification is an indicator as to whether you meet the minimum requirements for a loan, and how much of a loan you can be trusted with.
For those who are uncertain whether they’re financially ready for homeownership, prequalification can be an important step to getting on the property ladder.
How do I get prequalified?
To get prequalified, you’ll need to tell your potential lender some information relating to your income, credit score, assets and debts. In return, you’ll find out how much you could be approved to borrow.
Many lenders use a formula known as the debt-to-income ratio (often abbreviated to DTI) during mortgage prequalification. It comes in two forms: front-end DTI and back-end DTI. Front-end focuses on the amount of your home-related outgoings and expenses – this includes potential future mortgage payments, property taxes, homeowners’ association fees, and insurance. The total sum of these figures is then divided by your monthly income.
Back-end DTI involves adding your home-related expenses to the cost of all your other monthly debt. This can include personal loans, credit cards, car loans, and student loans. The final sum is then divided by your monthly income. For prequalification, most mortgage lenders will expect a back-end DTI ratio of 36% (or less), although certain government-backed homeownership programs may accept higher percentages.
Will getting prequalified affect my credit score?
If you’re ready for prequalification, you’ll be pleased to know that it will not affect your current credit score. Mortgage lenders typically base their prequalification reports on the information you give them and won’t pull up your credit report.
When a financier checks your credit report, this is what is known as a “hard enquiry”. Too many of these enquiries can actually lower your credit score, as it reveals that you’re trying to open multiple lines of credit in a short period of time. However, prequalification is different – shopping for the best mortgage rates is generally considered as the smart thing to do, given the responsibilities that come with a mortgage. Therefore, prequalification will not affect your credit score, even if the result is not the one you were hoping for.
How long does prequalification take?
Prequalification is a non-binding, informal evaluation of your creditworthiness. It generally only takes a day or two depending on the speed of the lender. Prequalification can be arranged in person, online or over the phone.
How can I prequalify for a larger loan?
If you’re unhappy with the amount you have prequalified to lend, you could improve your prospects by:
- Increasing your income: you could achieve this by asking for a raise or taking a second job.
- Consolidating or paying off debts: high-interest debt spread across several sources could be more manageable if it was consolidated into one monthly repayment. Better still, if you reduce your debts, you’ll be in a better position to command a larger loan.
- Improve your credit score: you can do this by using less credit, paying your bills on time, and correcting errors on your current credit report.