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Step 2 Mortgage and Finance |
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Loan Pre-Approval vs. Pre-Qualification |
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When you're under contract to buy a property, having your mortgage application denied (after waiting several weeks) may cause you to lose the property after having spent hundreds of dollars on loan fees and property inspections.
Even worse, you may lose the home that you've probably spent countless hours searching for and a great deal of emotional energy to secure. Some house sellers won't be willing to wait or may need to sell quickly. If the sellers have other buyers waiting in the wings, you've likely lost the property.
How could you have avoided this heartache? Well, you may hear some people in the real estate business, particularly real estate agents and mortgage folks, advocate that you go through mortgage pre-qualification or pre-approval. Here are some key differences between pre-qualification and pre-approval for a loan that you need to be aware of.
What is Pre-Qualification?
"Pre-Qualification" is an informal discussion between borrower and lender. The lender provides an opinion of the loan amount that you can borrow based solely on what you, the borrower, tell the lender. The lender doesn't verify anything and is not bound to make the loan when you're ready to buy.
Loan pre-qualification is a simple process. It takes into account very basic information regarding your financial status and gives you an amount for which you may qualify. This can be done strictly on a verbal level or electronically over the Internet. The pre-qualified amount is based solely on the information you provide. In most markets, pre-qualified buyers usually hold little clout compared to pre-approved buyers due to the fact that the information given during the pre-qualification process is not thoroughly investigated and therefore may be unreliable.
Where a pre-approved buyer is actually approved for a loan of a certain amount, a pre-qualified buyer is only told that they might be approved for a certain amount.
What is "Pre-Approval?"
Loan pre-approval is based on documented and verified information regarding your likelihood of continued employment, your income, your liabilities, and the cash you have available to close on a home purchase. A "Pre-Approval" means you have met with a loan officer, your credit files have been reviewed and the loan officer believes you can readily qualify for a given loan amount with one or more specific mortgage programs.
Based on this information, the lender will provide a pre-approval letter, which shows your borrowing power. A lender's pre-approval letter is considerably stronger than a pre-qualification letter.
Going through the pre-approval process is a sign of your seriousness to house sellers. It lets the seller know that you have gone through an extensive financial background check and there should be no unexpected obstacles to buying the home. This information is important to owners since they do not want to accept an offer that is likely to fail because financing cannot be obtained.
In a multiple-offer situation where more than one prospective buyer bids on a home at the same time, buyers who have been pre-approved for a loan have an advantage over buyers who haven't been proven creditworthy. A pre-approval letter shows that you have the ability to go through with a purchase.
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Reasons for the Pre-Approval Letter |
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Most home buyers know they should get a mortgage pre-approval letter from a lender before they begin seriously shopping for a home. But the reasons for this advice aren't always clear, and buyers sometimes are dismayed by the amount of paperwork involved. Here is some of the reasoning behind the advice:
A pre-approval letter is more reliable than a pre-qualification letter.
Getting a pre-qualification letter is easy. You just call a mortgage broker or lender, provide some basic financial information, then wait a few minutes for the letter to come through your fax machine. Getting a "pre-qual" from a Web site is just as easy. Enter some information; click "submit" and voila.
A pre-approval letter, on the other hand, involves verification of the information. Rather than taking your word on faith, the lender will ask for documentation to confirm your employment, the source of your down payment and other aspects of your financial circumstances. Granted, a pre-approval is more time-consuming (and possibly more stressful) than a pre-qualification. The additional due diligence is exactly why the pre-approval carries more weight.
You'll know how much money you can qualify to borrow.
Most home buyers have a rough idea of how much they would feel comfortable paying every month on their mortgage. However, there's no quick-and-dirty way to translate that monthly payment into a specific maximum mortgage amount because other factors -- down payment percentage, mortgage insurance, property taxes, adjustable interest rates and so on -- are part of the calculation. And, you might not be qualified to borrow as much as you think you should be able to borrow, depending on your income, your debts and your credit history.
You'll have more leverage in negotiations with the seller.
Sellers often prefer to negotiate with pre-approved buyers because the sellers know such buyers are financially qualified to obtain the financing they need to close the transaction. A pre-approval letter is an especially favorable point in a close multiple offer situation. And, you might feel more confident about making an offer with a pre-approval letter in hand and the knowledge that you'll be able to obtain a mortgage.
Your real estate agent will work harder on your behalf.
A pre-approval letter signals to your real estate agent that you're a well-qualified buyer who is serious about purchasing a home. The increased likelihood of a closed sale -- and a commission -- will naturally motivate your agent to devote more time and energy to you. In fact, some agents won't even show property to buyers who don't have a pre-approval letter.
You'll have less stress when choosing financing options.
Purchase forms often require buyers to apply for financing within a given time period, in many cases, seven to 10 days. By meeting with loan officers in advance and identifying mortgage programs, it won't be necessary to quickly find a lender, check credit, and rush into a financing decision that may not be the best option.
A few caveats.
Pre-approval letters aren't binding on the lender, are subject to an appraisal of the home you want to purchase and are time-sensitive. If your financial situation changes (e.g., you lose your job, lease a car or run up credit-card bills), interest rates rise or a specified expiration date passes, the lender will review your situation and recalculate your maximum mortgage amount accordingly.
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Step 1 Deciding to buy a Home
Step 2 Mortgage and finance