If you’re in the market for a new home, chances are you’ve already started shopping for the perfect place. But maybe the properties you’ve found seem a bit pricey, and you aren’t sure if you’ll get preapproved for such high amounts.
Of course, you want to only purchase a home if you can afford to make the monthly payments and maintain it. If so, there are ways to increase your mortgage preapproval amount and make your dreams of buying your first or next home a reality.
What is Mortgage Preapproval?
A mortgage preapproval provides you with a homebuying budget or the amount the mortgage provider is willing to lend to you. It involves the lender assessing your loan application and reviewing your credit score and history, along with the requested asset and income documentation, to determine how much you can comfortably afford to pay toward a mortgage each month. You’ll generally get a pre-approval letter that lists this amount so you can shop with confidence. A preapproval letter can also give you leverage when working with real estate agents and sellers to make offers and negotiate the best deal.
What Factors Determine Mortgage Preapproval Amount?
Here’s what mortgage lenders consider when coming up with a preapproval amount:
- Credit rating: The minimum credit score requirement depends on the loan program you select. However, the best rates are generally reserved for borrowers with strong credit scores. Furthermore, your monthly mortgage payment will be lower, and you could save a bundle in interest over the loan term. More on this shortly.
- Employment history: Most lenders want to see at least two years of employment history in the same industry and consistent earnings. The total amount you earn over this period will be divided by 24 months to come up with a monthly income figure used to calculate your preapproval amount.
- Monthly debt-to-income (DTI) ratio: This figure is computed by dividing the amount you pay for monthly debt obligations by your gross monthly income (or net monthly income if self-employed). Most lenders prefer that your DTI not exceed 43 percent, including your mortgage payment. But if you choose a government-backed loan program, a DTI of up to 50 percent (and sometimes higher) may be allowed. To illustrate how this works, assume your current monthly debt payments are $1,500 and your pre-tax income is $8,000. In this case, your monthly mortgage payment amount (including principal, interest, property taxes and homeowners insurance) shouldn’t be more than $1,940 ($8,000 * .43 – $1,500).
- Assets: The lender will also review your asset accounts to determine if you have a sufficient amount of funds available to cover the down payment and closing costs. The amount you’ll need depends on the loan program, and you may be able to receive gifts to help offset costs. You should also know that some lenders don’t require you to have the funds available when applying. If you’re short, the difference between what you currently have and what you’ll need will likely be listed as an outstanding condition that must be satisfied prior to closing.
- Reserves: You’ll likely need a few months of reserves, equivalent to the mortgage amount, to qualify for a home loan. Check with the lender to determine if this is a requirement for the loan program you’re considering. (Quick note: If you have a sizable amount of reserves in your bank account, the lender may be willing to loosen the credit score or DTI requirements).
Is It Possible to Increase Mortgage Preapproval Amount?
Whether you’ve already applied and weren’t satisfied with the mortgage-preapproval amount or plan to apply soon and wish to increase your buying power, there are ways to get it done. Below are some strategies to increase your mortgage preapproval amount:
- Add more income sources
- Pay off your debts
- Increase your credit score
- Prepare a large down payment
- Look for a lower rate or longer term
- Include a co-borrower
- Compare lenders and get multiple quotes
Ways to Increase Mortgage Preapproval Amount
This section dives deeper into the tactics you can use to get a larger home-shopping budget:
Add More Income Sources
Be sure to include all your income sources in your loan application. This includes government benefits, child support and alimony if you receive it. A higher income means you’ll have a lower DTI and can possibly get preapproved for a higher loan amount.
For example, if your current monthly debt payments are $1,100 and your earnings are $7,500, the maximum mortgage payment cannot exceed $2,125 ($7,500 * .43 – $1,100), and the lender caps the DTI at 43 percent. But if you receive $1,000 in child support, this amount increases to $2,555 ($8,500 * .43 – $1,100), giving you slightly more purchasing power.
Pay Off Your Debts
If you’re unable to beef up your income, you can pay off debts to improve your DTI. But if eliminating the balances completely is too heavy of a lift, allocate as much as you can towards your credit card balances to lower the minimum monthly payments. Or, if there are small loans you can pay off, consider doing so to cut at least one payment that would otherwise be included in the DTI calculation.
Increase Your Credit Score
As mentioned earlier, a higher credit score will generally get you access to a better interest rate. In the mortgage world, a slight decrease in the interest rate you receive means you’ll save several hundred or thousands of dollars over the life of the loan.
To illustrate, if you take out a 30-year, $325,000 conventional mortgage with a fixed rate of 6.25 percent, your monthly principal and interest payment will be $2,001, and you’ll pay $395,445 in interest over the loan term. But if your credit score is high enough to get a rate of 5.75 percent, the amount you pay monthly will drop to $1,896. Plus, the amount you’ll pay in interest over the life of the loan will be slightly lower at $358,146.
Prepare a Large Down Payment
A larger down payment means you can borrow less to purchase a home. It can also help you steer clear of private mortgage insurance that is usually added to your monthly loan payments until you reach at least 20 percent in home equity. But if you’re able to put at least 20 percent down, you’ll not only save in interest since you’ll be borrowing less, but you’ll also lower your DTI.
Look for a Lower Rate or Longer Term
The illustration above demonstrates the impact a lower rate can have on your monthly mortgage payment. But it’s not the only way to increase your preapproval amount. You can also select a longer term to lower the monthly mortgage payment amount and get preapproved for a higher loan amount. However, keep in mind that doing the latter also means you’ll pay more in interest as the lender will have more time to collect from you.
Include a Co-borrower
If your partner or an adult relative will be living in the home with you, ask if they’d be willing to be a co-borrower. Then, the lender can use their income when calculating the preapproval amount, assuming they meet the other eligibility requirements for the home loan.
Compare Lenders and Get Multiple Quotes
Never settle for the first preapproval you receive. Instead, shop around and get quotes from at least three lenders to determine which offers the most competitive loan terms. Consider getting prequalified first, though, if you can, as it’s a simple process that provides you with approval odds and loan estimates without impacting your credit score.
