What does it mean to be pre-qualified or pre-approved for a mortgage? The two words are often used interchangeably, but they aren’t the same thing and don’t carry the same weight when a hopeful homeowner is ready to buy.
Here’s a look at how these two terms vary, how much each can play a significant part in any home buying strategy, and how one, in particular, can increase the chances of having a purchase offer accepted when there are multiple offers on a house.
Getting pre-qualified for a mortgage is a relatively quick and easy process.
You, the mortgage applicant, provide a few financial details to a lender. The lender uses this unverified information, usually along with a soft credit pull (which will not impact your credit score), to let you know approximately how much you may be able to borrow and at what terms.
Because pre-qualification is an estimate of what the lender thinks you can probably afford based on the data input, the lender may ask some clarifying questions around income, assets, employment, and debt. You likely won’t be asked to provide any documentation at this point, so it’s pretty painless.
Getting pre-qualified can give an applicant a general idea of loan programs and the amount they may be eligible for. But because the information provided has not been verified, there’s no guarantee that the loan or amount will be approved.
That doesn’t make this step irrelevant, though. Pre-qualification can help you in a few ways:
- It can give you an idea how much house you can afford
- It can alert you to loan programs you may be eligible for
- It can tell you what your monthly payment might look like when you do get approved for a mortgage
It might be tempting to provide embellished financial information to lenders or to skip the pre-qualification process entirely. But who wants to fall in love with a house they can’t potentially afford? And who wouldn’t want to eliminate any mortgage programs or lenders that don’t suit your needs? Don’t skip the step.
How is getting pre-approved for a mortgage different?
Once you decide on a mortgage lender or lenders, you can begin the pre-approval process.
Pre-approval takes longer than pre-qualification and requires a thorough investigation of your income sources, employment history, assets, credit history, and other financial commitments and debts.
Verification of this information, along with a hard credit pull from all three credit bureaus (if you go to multiple lenders within 45 days it will count as only one pull) allow the lenders to complete a pre-approval.
When seeking a pre-approval, besides filling out an application, you may be asked to submit the following for verification:
- Social Security number and some other s of identification
- Two most recent pay stubs
- W-2 statements for the past two years
- Sixty days worth of documentation of the activity in checking, savings and investment accounts
- Residential addresses from the past two years, including contact information for rental companies or landlords if applicable.
The lender may require backup documentation for certain types of income in order to qualify for a mortgage. For example, rental property owners may be asked to show lease agreements. Freelancers may be asked to provide 1099 forms, bank statements, a profit and loss statement, a client list, or work contracts.
Buyers can also expect to have to explain negative information that might show up during a credit check. To avoid any surprises, proactive buyers can get free credit reports from various companies online such as freeannualcreditreport.com. A credit report shows all balances, payments, and derogatory information but does not give credit scores. It may help potential borrowers identify and amend errors before applying for a loan.
Those who have filed for bankruptcy in the past may have to show documentation that it has been discharged. Applicants face a waiting period (which varies with the lender and whether they are seeking a conventional vs government home loan) after bankruptcy dismissal or charge and before being eligible for new loan approval.
The lender will need to verify the amount and source of the down payment you plan to provide. If your parents are giving you some cash, for example, the lender will ask for a gift letter that confirms the money is a gift and not a loan. Some loan programs may require you to contribute a certain amount of your money (sometimes 5%) to the loan before a gift can be applied. Generally, investment properties are not eligible for gift funds.
Those taking a loan or withdrawal from a 401(k) also typically will have to show paperwork. Also, any sudden changes in finances have to be explained, and it’s important to have a paper trail.
Three Reasons to Get Pre-Approved
Sounds like a lot of work, right? But pre-approval has at least three major selling points.
- Pre-approval lets you know the specific amount you are qualified to borrow from the lender, instead of just an estimate. You can always purchase a house for less than the pre-approved amount.
- Going through pre-approval before house hunting could take some of the stress out of the loan process by breaking up the borrower and property underwriting portions of the loan. Underwriting, the final say on mortgage approval or disapproval, comes after you have been pre-approved, found the house you love, agreed on a price, and applied for the home loan.
- Being pre-approved for a loan helps to show sellers you’re a vetted buyer. The lender can provide a pre-approved letter that indicates the willingness to lend you a particular amount, and the interest rates and fees you can expect to pay on that loan (though it’s not a guarantee that you’ll get the loan).
In a challenging real estate market it’s not surprising that sellers might receive offers from multiple buyers. Having a pre-approved letter could improve the chances that your offer will be accepted, especially if others lack a pre-approval letter. The letter tells the seller that your credit, income, and assets have been reviewed and approved by a lender to move forward and, if the property is eligible, the loan should close with no issues to derail the purchase.
Time Is of the Essence
A pre-approval letter usually expires in 90 days because pay stubs, bank statements, and so on are considered dated after 90 days.
If the information needs to be updated and reverified after that point, the pre-approval letter can be reissued with a new expiration date.
Finalizing the Mortgage Application
After you find the house you want to purchase and the seller has accepted the offer, the next step is to finalize the mortgage application and move towards loan approval. You don’t have to choose a mortgage from the same place the pre-approval letter came from.
Once the lender receives the property appraisal, a loan underwriter reviews the data and issues a loan commitment or final approval. This means the loan has been fully approved.
The lender may perform another credit check right before a loan closes. Applying for new credit cards or auto loans, or making large credit purchases during the home buying process could affect the final mortgage approval.
Some borrowers choose to lock in the interest rate offered by the lender once they find a home they want to buy. This freezes the mortgage rate for a predetermined period.
It’s a good idea to verify the time period to make sure the rate is in effect through the closing and to review the fully executed purchase contract with the lender for closing and loan contingency timelines to be sure contract dates can be met.
Finally, even if you pass the loan approval process with flying colors, the home being purchased might not. If the sales price is higher than the appraisal value, you may have to go back to the negotiating table, walk away from the deal, or come up with cash to make up the difference.
What if My Pre-Approval Didn’t Work Out?
Being turned down for a mortgage or not being able to borrow as much as you expected can be disappointing. But it doesn’t have to put a stop to your home buying hopes.
If you are in that spot, you might want to try to understand why you are not approved. You could:
- Consider another loan product or lender where you might meet the lending criteria
- Work on improving whatever put a kibosh on your home application
- Find a home that’s better suited to your budget if you were pre-approved for a lower amount than expected
Pre-qualification vs pre-approval: If you’re serious about buying a house, you now know the difference. Getting pre-qualified and then pre-approved may increase the odds that your house search will lead to home ownership.