Know what a lender sees before you apply.

Before you fall for a house, it helps to know how a lender will see you. A preapproval letter gives you a realistic sense of how much you can borrow, and it tells sellers you’re a serious buyer. Just as important, the process gives you a chance to spot problems while there’s still time to fix them.

It’s less mysterious than it sounds. Lenders mainly want to understand how you’ve handled credit, how your income compares with what you owe and whether you can document the money you’ll use to buy.

Prequalification versus preapproval

You’ll hear both words. Each describes a letter from a lender saying it’s generally willing to lend you up to a certain amount, based on certain assumptions. Neither one is a guaranteed loan offer.

Lenders use the terms differently. Some issue a prequalification based on information you report without checking it, and save “preapproval” for after they’ve verified your information. Others may call the same kind of letter by either name. So don’t worry too much about the label. Ask the lender what it actually reviewed. A local real estate agent or a housing counselor at a HUD-approved agency can tell you whether a letter will carry weight with sellers in your area.

Many people wait to get preapproved until they’re ready to shop seriously. Getting preapproved earlier can help you find credit issues in time to correct them. And if a lender reviews your credit and tells you that you don’t qualify for a letter, it must give you an adverse action notice.

What lenders look at

Your credit

When a mortgage lender checks your credit, it reviews your credit report and scores. Before that happens, look at your reports yourself. You can get free copies at AnnualCreditReport.com. Checking your own credit doesn’t affect your scores. If you find mistakes, work to get them corrected as soon as possible.

Your debt-to-income ratio

Your debt-to-income ratio, or DTI, is all your monthly debt payments divided by your gross monthly income. Gross income is what you earn before taxes and other deductions come out. DTI is one way lenders measure whether you can manage the payments on a new loan.

Here’s a simple example. Say your monthly debt payments would be:

• $1,500 for a mortgage
• $100 for a car loan
• $400 for your other debts

That adds up to $2,000 a month. If your gross monthly income is $6,000, your DTI is about 33%, because $2,000 is about a third of $6,000.

Different loan products and lenders have different DTI limits. Paying down a balance lowers the debt side of the math.

Your income and assets

Lenders verify what you tell them, so it helps to gather your paperwork before you talk with them. A typical packet includes:

1. A pay stub covering the last 30 days
2. W-2 forms for the last two years
3. Signed federal tax returns for the last two years
4. Records of any other income
5. Your two most recent bank statements
6. Account statements showing where your down payment is coming from, with at least two months of history. If some of the money is a gift, include a signed statement from the giver saying so.
7. Proof of identity, such as a driver’s license, and your Social Security number

If you’re self-employed or have irregular income, you may need more documents. Requirements vary, so ask each lender early. Include every page of multi-page documents, even pages marked “intentionally left blank.”

Shop around without worrying about your score

Each time a lender checks your credit, it’s recorded as an inquiry. An inquiry typically has a small negative effect on your scores. But credit scoring models generally count several mortgage credit checks made within a short period as one inquiry, because lenders know you’re only buying one home. That period is 45 days for some scoring models and 14 days for others, so it’s safest to do your rate shopping within about two weeks.

That means you can get preapprovals and official offers, called Loan Estimates, from several lenders. Even if a check falls outside that window, shopping around is usually still worth it. The effect of one more inquiry is small, and a better deal can save you a lot over time.

Keep things steady until closing

A preapproval isn’t the finish line. Your lender uses the information you provide to decide how much to lend and at what interest rate, so keep it accurate and up to date. Expect to send fresh bank statements and pay stubs at least once along the way.

Be careful with new credit, too. Applying for a credit card, car loan or other loan creates another inquiry that can lower your scores. Try to avoid it right before you apply for a mortgage and during the mortgage process. If you were planning to finance new furniture, it can wait until after closing.

Your next step

Today, request your free credit reports at AnnualCreditReport.com. Read each one line by line, and make a note of anything you don’t recognize. That short list is your first, most useful piece of mortgage homework.