A pre-approval is only as strong as the paperwork behind it. If a lender writes you a letter before seeing your documents, it is guessing. Here is what to gather, why each item is on the list, and what changes if you are self-employed, retired or getting help from family.
Key takeaways
- A pre-approval is based on verified information. A pre-qualification is often based on what you tell the lender. Neither is a guaranteed loan offer.
- W-2 employees typically need 30 days of pay stubs, two years of W-2s and recent statements for every account they plan to use.
- Self-employed borrowers, meaning anyone with 25% or more ownership in a business, generally need two years of tax returns.
- A single deposit over 50% of your monthly qualifying income may need a paper trail if you need that money to close.
- Fannie Mae requires documents to be no more than four months old at closing, so expect updates on a long search.
Pre-approval vs. pre-qualification
The two terms sound alike, and lenders don't use them consistently. The CFPB explains that some lenders offer a pre-qualification letter "based on unverified information that you report," and "will only issue a preapproval letter based on verified information." The CFPB also notes that neither letter "is a guaranteed loan offer."
Freddie Mac's step-by-step mortgage guide describes a pre-approval letter as "the lender's conditional commitment to lend you a specific amount of money for the purchase of your home."
The practical difference shows up after you are under contract. If a lender verified your income, assets and credit up front, there is less left to discover later. So whatever the letter is called, ask what the lender actually reviewed before writing it.
The core checklist for W-2 employees
Freddie Mac's guide lists the documents you will most likely need to complete a mortgage application. Fannie Mae's Selling Guide sets the underwriting rules behind them.
- Pay stubs for the last 30 days. Under Fannie Mae's employment documentation standards, a pay stub must be dated no earlier than 30 days before your application and must include all year-to-date earnings. The lender uses it to confirm your current pay rate and that you are still on payroll.
- W-2s for the past two years. Fannie Mae requires W-2s covering the most recent one- or two-year period, depending on the income type. W-2s show whether your income is stable or rising, which matters most if you earn overtime, bonuses or commission.
- Recent statements for all bank, investment and retirement accounts. These show you have the down payment, closing costs and any reserves the loan requires.
- Information about your debts. Car loans, student loans, credit cards, child support and any other monthly obligations. Freddie Mac's guide notes that the lender will compare what you list against your credit report, and that "differences between your figures and those on the credit report will raise questions and may delay the decision."
- Proof of any other income you want counted, such as alimony, child support or rental income.
- Personal details. Your Social Security number, date of birth and contact information. If you have lived at your current address less than two years, be ready to list former addresses. If you are not a U.S. citizen, you will be asked about your residency status.
- Permission to pull credit and tax transcripts. You will authorize a credit report. Many lenders also ask you to sign IRS Form 4506-C, which lets the lender request your tax transcripts through the IRS Income Verification Express Service. The IRS says it releases those records only with your consent.
Once you have these together, run your numbers through our debt-to-income calculator. Your debt-to-income ratio is one of the first things an underwriter looks at.
If you're self-employed
Fannie Mae considers anyone with a 25% or greater ownership interest in a business to be self-employed. That changes the documentation, because pay stubs don't tell the whole story when you control your own pay.
- Two years of signed personal tax returns, or IRS transcripts for the same years. Fannie Mae generally requires a two-year history of earnings.
- Business tax returns in many cases. Fannie Mae allows them to be waived in limited situations, such as when you use personal funds to close, the business has existed for five years and your self-employment income has increased over the two years.
- One year of returns may be enough if the business has existed for five years and you have held at least 25% ownership for five consecutive years.
- Less than two years in business can still work if your most recent returns show a full 12 months of income from the current business and you previously earned the same or more in the same or a similar field.
If you plan to use business funds for the down payment, Fannie Mae's guide calls for several months of recent business account statements and, in some cases, a current balance sheet. If your tax returns understate what you actually earn, a bank statement loan may fit better. Our guide to self-employed bank statement loans covers how those programs work.
If you're retired
Retirement income is documented differently from a paycheck, and the lender cares about how long it will last.
- Social Security: Fannie Mae accepts the SSA award letter, an SSA-1099, your most recent signed tax returns or proof of current receipt, under its Social Security income rules. For benefits based on your own work record, lenders generally don't need to verify that the income will continue.
- Pensions and annuities: a statement from the payer, an award letter or benefit statement, a bank statement, a tax return, a W-2 or a 1099, according to Fannie Mae's retirement income section.
- IRA or 401(k) distributions: the lender must document that the income will continue for at least three years from the application date. You need unrestricted access to the accounts without penalty. Bring current statements so the lender can confirm the balance supports the distribution.
Gift funds
Help from family is common, and it is allowed, but it has to be documented. Under Fannie Mae's personal gift rules:
- The donor must be a relative or someone with a family-type relationship, such as a domestic partner or fiancé. The donor can't be connected to the builder, developer, real estate agent or another interested party.
- The gift letter must be signed by the donor, state the dollar amount, say that no repayment is expected, and give the donor's name, address, phone number and relationship to you.
- The transfer must be documented, for example with an electronic transfer record, or a copy of the donor's check and your deposit slip. The donor can also send the funds directly to the closing agent.
- How much can be a gift: on a one-unit primary residence, all of the funds can come from a gift. On a two- to four-unit primary residence or a second home with more than 80% financing, you need to contribute 5% from your own funds. Gifts are not allowed on investment properties.
Other loan programs have their own gift rules, so confirm with your loan officer before money moves.
Large deposits
This is the item that surprises people most. Fannie Mae's depository account rules define a large deposit as "a single deposit that exceeds 50% of the total monthly qualifying income for the loan." If you earn $8,000 a month, any single deposit over $4,000 qualifies.
On a purchase, if you need those funds for the down payment, closing costs or reserves, the lender must document that they came from an acceptable source. If it can't, the guide says "verified funds must be reduced by the amount (or portion) of the undocumented large deposit." That can leave you short at closing.
Typical large deposits include a bonus, a tax refund, the sale of a car, a transfer from another account or cash you have been keeping at home. Each one is usually easy to explain if you keep the paperwork: the bill of sale, the statement from the other account, the payroll record. Write a short letter of explanation for anything unusual before the underwriter asks.
Why your documents expire
Fannie Mae requires credit reports and employment, income and asset documents to be no more than four months old on the date your loan closes. A pre-approval from the spring may need new pay stubs, new statements and possibly a new credit report by summer.
Fresh documents also show anything that changed. If your income, debts or balances moved, the lender will see it. Before you shop, it is worth checking your own credit and cleaning up errors. Our guide on how to improve your credit score before a mortgage application walks through it.
Shopping lenders without hurting your credit
You can compare pre-approvals from more than one lender. According to the CFPB, "within a 45-day window, multiple credit checks from mortgage lenders are recorded on your credit report as a single inquiry." The CFPB also suggests you "try to avoid applying for these other types of credit right before getting a mortgage or during the mortgage process."
What this means for you
The best time to gather these documents is before you find the house. A complete file lets the underwriter review your income, assets and credit up front, so your offer carries a letter that means something and there are fewer surprises once you're under contract.
Start a folder now: the last 30 days of pay stubs, two years of W-2s or tax returns, every page of your last two months of statements, and paperwork for any gift or large deposit. If you are buying your first home, our first-time homebuyer page covers the rest of the process.
Cedar Home Loans has offices in Boulder, Vail and Telluride. When your documents are ready, start your pre-approval or call us at (303) 549-5277. Cedar Home Loans NMLS #1660298. Andrew McBryan NMLS #304312.
Sources
- CFPB — What's the difference between a prequalification letter and a preapproval letter?
- CFPB — What happens when a mortgage lender checks my credit?
- Freddie Mac — Your Step-by-Step Mortgage Guide: From Application to Closing
- Fannie Mae Selling Guide — B3-3.1-02, Standards for Employment Documentation
- Fannie Mae Selling Guide — B3-3.2-01, Underwriting Factors and Documentation for a Self-Employed Borrower
- Fannie Mae Selling Guide — B3-3.4-15, Social Security Income
- Fannie Mae Selling Guide — B3-3.4-03, Annuity, Pension, or Retirement Income
- Fannie Mae Selling Guide — B3-4.3-04, Personal Gifts
- Fannie Mae Selling Guide — B3-4.2-02, Depository Accounts
- Fannie Mae Selling Guide — B1-1-03, Allowable Age of Credit Documents and Federal Income Tax Returns
- IRS — Income Verification Express Service for taxpayers
